Tax Efficient Investing: A Beginner's Guide
One of the most important things I've learned about tax efficient investing is that the playing field keeps changing. With taper relief, it used to be really efficient to have a large AIM portfolio - now it isn't. You used to get capital gains tax rollover through VCTs - now you don't.
However, there are still plenty of ways to invest in a tax-efficient way. The most obvious for any stock market investor is of course the ISA. You can put £7,200 this year, unless you're over 50, in which case you can invest £10,200 - next year, that goes up to £10,200 for everyone. Most brokers offer a self-select ISA (I'm assuming most Stockopedia readers won't want to buy funds). Over time, you can build a fairly significant ISA portfolio.
An ISA will give you several advantages. No CGT. No income tax on dividends (though you still pay 20% through the tax credit which can't be reclaimed). And no need to fill in anything about it on your tax form. While the income tax break isn't significant unless you're paying higher rate tax, the CGT tax break can be very useful. You can take profits on your positions without having to worry about whether you're going to incur CGT. A £100,000 portfolio might only generate £4,000 in dividends a year - but you're much more likely to incur over the £9,200 capital gains tax threshold of profits.
Now you can also gain efficiencies by investing in a SIPP (or indeed any other pension scheme). The tax benefit here is up front - you can claim your contributions as an allowance against your income tax liability. I won't go into it in detail - that would take another article! - but subject to the lifetime and annual limits this can be an efficient way to invest.
VCTs are another useful break. These are investment trusts which invest in smaller companies and comply with various stringent regulations; you can invest up to £200,000 a year (rather a lot more than with an ISA!) and you can get 30% tax relief on that. I regret immensely that I overpaid about fifty thousand quid to the government because none of my so-called financial advisers ever told me about these! I had to find out for myself.
To get the up-front tax relief you have to subscribe to a new VCT issue. But there are also advantages to buying second-hand shares, since all VCT dividends and capital gains are tax free. So if you have a large enough portfolio to be paying CGT most years and can't shelter all of it in an ISA, if you ask me, VCTs make good sense as an investment.
What's wrong with VCTs? Plenty. They invest in smaller companies so can be high risk. And they are often very illiquid, so really not suitable if you're going to need the money. I don't like to call it 'investment', but for more active investors wanting to make some of their capital gains tax free, spread betting has its attractions. The Inland Revenue says it's not investing, it's gambling - so there is no tax payable on your winnings. If, of course, you have any.
A small and often overlooked tax that you may be able to save on is stamp duty. You only have to pay stamp duty on UK domiciled stocks, so if you're buying a Channel Islands based fund such as £3iN, or shares in an Irish or Chinese company, you shouldn't have to pay stamp duty. If you do buy stocks that are foreign based, remember to check that your broker hasn't automatically applied stamp duty by mistake.
Finally, remember that planning your capital gains can help you minimise your liabilities. By this I mean that if you have a large slice of profit in your portfolio, try to take the whole £9,200 of gains that you're allowed tax-free every year by taking a profit on some positions. (Remember not to buy the same stock back within 30 days or it won't work.) That reduces your overall gains and means you're less likely to pay CGT in future years.
The tax man will inevitably take some of what you earn - and rightly so! But by using your tax allowances and tax-free savings schemes to the full, you can minimise what you're giving to the government - and do so, I hasten to add, completely legally!
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8 comments
How about financial spread betting. It's totally tax free, at least now, and no form to fill and all the profits are tax free.
Will changes come into force at midnight on the day of the (early March?) budget or April 6th?
Who knows?
But even if there is a window of opportunity for shares (it will be too short to be of any use for property) , then I would expect some significant selling during the period, so you would have been better off to sell before the budget any way. I am planning a review in early Feb (ie as soon as the blessed tax forms are done).
db
In reply to doverbeach (post #4)
Yes, 18% CGT does look set to rise but will we get a window of opportunity to consider our options in knowledge of any changes before the axe falls? Will changes come into force at midnight on the day of the (early March?) budget or April 6th? Would be useful to know. If they revert to the old system, CGT will be stepped from 20% to 40% depending on income. But then it might go to 40% across the board for equities, who knows? Depending on one's situation, it might not be worth selling for a 2% advantage but would be for 22%....always bearing in mind the goodly tax advice on investments in Post 1, plus considerations relating to those having already 'spent' the current tax free allowance.
Very good point, doverbeach (and, indeed, the other posters!).
CGT rates must surely rise, in the spirit of a progressive tax system hitting those who are relatively better-off (ie have savings). Whilst one might fairly argue that prudent savers shouldn't be hit instead of the profligate spenders (as a matter of simple equity) the sad fact is that the profligate spenders don't have any cash left - so a hard-up government is certain to tax harder anyone who still does.
In that context, if I was an owner of multiple homes in the UK, I'd be very tempted to be selling up right now - because I'd suspect that the days of property investing being as safe as houses will be coming to an end pretty sharpish. I've no idea what form a greatly-increased tax take might take and how the rules might be framed to avoid damaging the rented sector - but I strongly suspect that (broadly speaking) people who own property worth more than £1mn in aggregate may find themselves paying substantial amounts of taxes merely on holding those assets.....
.....which would make the taking of the annual abilityto shelter £10,100 in an ISA even more valuable than it is at present!
The other post-election effect to watch for is that interest rates will surely have to rise significantly at some point - and that may well suck money out of the stock market.....especially in the sort of income-paying stocks favoured by investors who have rushed to the stock market over the last year to try to stem the dramatic falls in portfolio yields.....
....so IMO interest rate rises are another reason to be cautious about the housing market - and an excellent reason to be VERY careful which sectors your ISA funds are invested in. Personally I will continue to avoid "high-yielding" old economy stocks in my ISA - the dominant value of an ISA is in sheltering capital gains.....and if you want to draw income from it then selling a few shares to raise funds may well be cheaper than paying a premium for low-growth dividend-paying stocks, especially if one has sheltered the capital gains!
ee
The other thing is that CGT is at a pretty low 18% rate at the moment. Personally I think it is highly illogical that this isnt in line with higher rate tax. And in today's economic climate, I would not be surprised to see the rate be increased in the next tax year. So anyone with significant rolled up profit might thing of taking the tax hit this year...
db
Thanks for the comments/clarifications - they are greatly appreciated. Best, Anna
try to take the whole £9,200 of gains that you're allowed tax-free every year by taking a profit on some positions.
In fact, the current CGT allowance for 2009/2010 is £10,100. One can of course double up this allowance through joint ownership with one's partner, making £20,200 tax free allowance available for couples in the current year.
The tax credit on dividends is entirely notional - i.e. there is no tax actually paid that this credit represents, so not being able to reclaim it in within an ISA or pension plan etc, is not as much of a problem as it first seems.
It is true that for basic rate taxpayers, ISAs aren't likely to save much by way of tax however a regularly maximised ISA will build up over time, hopefully saving at least some CGT and income tax, and has the benefit of not requiring any tax reporting, and also for those over 65 any withdrawals from it do not reduce the enhanced age allowance for income tax.
The tax benefits of pension contributions for a basic rate taxpayer need to be weighed against the severe restrictions on access and what you can eventually do with the pension fund, and on those grounds are inferiors vehicle to ISAs for BRT'ers.
Irish Stamp Duty is 1% if I remember correctly, so higher than the 0.5% UK SDRT - if in doubt always check with the broker first as CREST imposes rules that are not immediately obvious based on a simple assumption about a company's jurisdiction.
Tax efficiency should, for most people, be one of the last considerations when investing - I say this as a Chartered Financial Planner - far more important considerations include objectives, risk attitudes, timeframes, access and administration.