Five ways to invest tax efficiently

Esther Shaw / 16 November 2015 ( 05 April 2017 )

Minimise the tax you pay on your savings with these tax efficient investments.

When it comes to investing, it is vital to minimise the tax you pay on your savings.

There are a number of ways in which you can shelter money from the taxman, and the most popular options include ISAs and pensions.

Higher-risk investors could choose a Venture Capital Trust (VCT) or Enterprise Investment Scheme (EIS), which offer some of the biggest tax savings – but be warned: these are not for the faint-hearted.

Individual savings accounts (ISAs)

An ISA is a tax-efficient way of holding cash, shares, bonds and collective funds, such as unit trusts.

ISAs lock money away from the taxman while allowing you to gain access to it.

From April 2018, the ISA allowance is £20,000.

You can opt to hold all of your allowance in cash or in shares – or in a combination of the two.

This means you can hold some of your money in a cash ISA held with a bank or building society, and some in a stocks-and-shares ISA with an investment provider. Over the longer term, you are likely to earn better returns by investing your allowance in a stocks and shares ISA.

You do not have to declare income from an ISA on a tax return.

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Pensions are another way to invest tax-efficiently for the time when you retire.

There are different types of schemes, including workplace schemes (where contributions are taken direct from your salary), personal and stakeholder pensions run by insurers, and self-invested personal pensions.

Money invested in a pension grows free from income tax or capital gains tax.

In the current tax year you can invest £40,000 into a pension scheme on which you receive tax relief at your marginal rate of income tax.

Read more about the different types of pension

When it comes to retirement planning, it is advisable to use a mix of both pensions and stocks and shares ISAs.

Pensions give initial tax relief, though aren’t particularly flexible, whereas ISAs are tax-efficient but provide much greater flexibility.

Read our guide to investments for beginners

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Venture capital trusts (VCTs)

VCTs are stock market traded funds that invest money into a collection of small companies. They are often high risk, but the Government offers generous tax breaks to encourage as many people as possible to back such firms.

You can slot away up to £200,000 each tax year and there is a 30% income tax relief on the money you invest, provided you have paid at least as much in tax as you invest.

Any gains or dividends are free from income tax and there is no capital gains tax when the investment is sold – as long as the shares have been held for five years.

Crucially, you should only consider VCTs if you have a broad investment portfolio in place and understand the risks involved.

Read Annie Shaw's guide to common investment mistakes

Enterprise investment schemes (EIS)

EIS funds are specialist funds that put investors’ money into a single start-up business.

The limit on annual investment in the EIS is £1 million, and you get a 30% income tax refund on the money you invest, provided you have paid at least that much in tax in the year you invest. Any growth is free from capital gains tax.

Both reliefs depend on holding the shares for at least three years (slightly lower than the requirement for VCTs).

If you are considering EIS funds, it is important not to underestimate the risks.

Seed enterprise investment schemes (SEIS)

You can also put up to £100,000 a year into the seed enterprise investment scheme for start-up firms and get tax relief at 50%. However, SEIS qualifying firms are very small, and at an early stage of development, so once again, you need to tread extremely carefully. 

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