For higher earners in particular, cuts to pension allowances and some forms of tax relief in recent years have resulted in the erosion of capital.
But with some tax incentives allowing investors to pay no income or capital gains tax on returns, claim loss relief, pass on investments free of inheritance tax and more, there is potential to maximise returns, minimise risk and reduce an often substantial tax bill.
The tax incentive most appropriate will depend on the asset you’d like to invest in, as well as your personal circumstances and investor classification. But four of the most generous available are the Individual Savings Account (ISA), Enterprise Investment Scheme (EIS), Seed Enterprise Investment Scheme (SEIS) and non-standard pensions such as the Self-Invested Personal Pension (SIPP) and Small Self Administered Scheme (SSAS) – and understanding what each of these tax-efficient investment routes have to offer is critical.
Individual Savings Account (ISA)
Since its introduction in 1999, the ISA has become a household name. Its account offerings have changed over the years, but the main tax-efficient benefit of the ISA has remained the same – all returns are free from income and capital gains tax.
Now with four main Adult ISAs to choose from – the Cash ISA, Innovative Finance ISA (IFISA), Stocks and Shares ISA and Lifetime ISA – and a generous £20,000 ISA allowance (as of 2021/22), there is something for all savers and investors.
The Cash ISA – while offering rock-bottom low interest rates, making it almost impossible for capital to grow within the account – may be an appropriate choice for cautious savers with its status as a savings product and Financial Services Compensation Scheme (FSCS) protection.
On the other hand, experienced investors could target potential returns of between 4% and 8% with the IFISA, an investment account which allows tax-free investment into peer-to-peer loans and debt-based securities – though as with all investments, capital is at risk and returns are not guaranteed.
With the IFISA, investors can hold the popular asset of property — both commercial and residential – as well as SME and consumer loans and green energy projects within the tax wrapper.
For experienced investors looking to take advantage of the stock market, the Stocks and Shares ISA offers potential returns in excess of 4%. These returns can in reality be considerably greater, but conversely, they can be considerably less given the immense volatility investors can experience with the stock market.
Because the stock market is volatile, it should be considered a long-term investment option, allowing time for falls in value to recover, and as with all investments, capital is at risk and returns are not guaranteed.
Enterprise Investment Scheme (EIS)
The EIS offers some of the most generous tax incentives for investors into high-growth, early-stage businesses.
It was established in 1994 and offers tax reliefs which seek to help investors into unlisted small and medium-sized companies offset the higher associated risks.
To do this, the EIS allows investors to:
claim back up to 30% of the value of an investment
dispose of shares without paying capital gains tax
defer the payment of capital gains tax
claim loss relief if the business fails
pass on investments free of inheritance tax
But the headline-grabbing tax reliefs aren’t the only advantages of the EIS.
In 2019, small and medium-sized businesses accounted for three fifths of employment in the private sector in the UK, as well as around half of its turnover. Meaning that supporting SMEs through the EIS results in investing for impact – as small businesses will be crucial in the bounce-back of the UK economy post-Coronavirus.
In order to be EIS-eligible, businesses must be unquoted, have less than 250 full-time employees, have gross assets of less than £15 million, and be within seven years of their first commercial sale.
Whilst this criteria is strict in some respects, it opens the EIS up to a considerable number of companies, with 31,365 (as of 2018/19) having received investment through the incentive since its introduction and £22 billion of funds having been raised.
Seed Enterprise Investment Scheme (SEIS)
Similar to the EIS, the SEIS was introduced in 2012 to focus on smaller – and therefore higher risk – businesses.
To be SEIS-eligible, businesses must be unquoted, less than two years old, have less than 25 full-time employees, and have gross assets for less than £200,000.
But as a result of the earlier stage of the businesses, investors are provided with even more generous tax reliefs.
income tax relief of up to 50%
50% capital gains reinvestment relief
no capital gains tax on profits
inheritance tax relief
With these additional tax reliefs, investors can support the next generation of British businesses at the very start of their journey, but with the ability to mitigate a large amount of risk — an SEIS investment of £10,000, for example, could in reality mean a higher rate taxpayer has just £2,750 of capital at risk once all tax reliefs are accounted for.
When exploring tax-efficient methods of investing, pensions are often overlooked. But with a lifetime allowance of £1,073,100 (as of 2021/22) and tax relief on contributions, making the most of their tax efficiency is key.
And for experienced investors looking for increased control over their pension pots, SIPPs and SSASs offer just that.
A SIPP is a DIY pension allowing experienced investors who are able to make their own investment decisions to choose where their retirement savings are invested.
On the other hand, a SSAS is an employer-sponsored defined contribution workplace pension scheme that can be independently managed by a company for 11 members or less.
Depending on your marginal rate of tax, it’s possible to receive up to 45% tax relief on both SIPP and SSAS contributions, whilst investments also grow free from income and capital gains tax and you are often able to withdraw 25% of the pension fund tax-free.
On top of the obvious tax-efficient and freedom of choice advantages, a SIPP and SSAS also allow investors to hold a much broader range of investments than a standard pension. These include bonds, commercial property, offshore funds and more.
It is worth highlighting that each SIPP and SSAS provider have their own criteria, and alternative investments – such as property bonds – shouldn’t be considered a pre-approved option. However, numerous providers allow SIPP and SSAS holders to incorporate such assets into their pension once the relevant due diligence has been completed.
Investing in a tax-efficient manner
It’s clear that there are a multitude of tax-efficient options available when it comes to investing.
Whether you’re an experienced investor looking for a hands-off method of investing into property, or you’d like to back the next wave of British business, the ISA, EIS, SEIS, SIPP and SSAS offer unrivalled tax reliefs to aid in maximising returns and minimising risk.