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What can I do to maximise my tax efficiency?
Sarah Pennells of
None of us wants to pay more tax than we have to, but many of us do just that because we don’t make the most of our tax allowances. You don’t need a fortune to start investing tax-efficiently and there are lots of ways you can get started:
An ISA is not an investment in itself but it is a wrapper that you can use to shelter your investments from tax. This tax year (2010/11), you can pay up to £10,200 into an ISA, of which you can hold £5,100 in a cash ISA. From the beginning of the next tax year (6 April 2011), the allowances will increase in line with inflation.
TIP: There are two different types of ISA: cash and investment. Your total allowance in each tax year is £10,200, so if you invest £5,100 in a cash ISA, you can still put a further £5,100 in an investment ISA (or you can hold all of your allowance, including the cash element, in an investment ISA). Remember, if you don’t use your ISA allowance within the year, you will lose it as it can’t be carried over. Don’t forget tax rules can change and their impact on you depends on your personal circumstances.
It is important to think carefully about what you want to invest in and check that it is eligible to be placed in an ISA and you should take independent financial advice if you need it. If you want to be in control of your investments, you can opt for a self-select ISA, where you pick all the investments yourself.
Often the most tax-efficient way to invest can be through a pension because you get tax relief on pension contributions, plus any growth within the fund is free of income and capital gains tax (except for dividends which are subject to 10% tax). When you retire you can generally take a tax-free lump sum of up to the value of 25% of your pension fund. The value of any tax benefit does depend upon your personal circumstances.
Make use of your capital gains tax (CGT) allowance
If you want to generate profits in a tax-efficient way you can do this by choosing investments designed to produce capital growth. So, even though investments like shares, funds, and exchange traded funds are not tax-efficient investments, they can be if they are used in the right way.
Each tax year, you have a capital gains tax allowance of £10,100. This means you can realise tax free capital gains up to this value in each tax year.
TIP: Be prepared for a bit of work. You’ll have to decide (with an adviser, unless you are happy making your own decisions) which investments to sell when, as well as paying the transaction costs.
Venture Capital Trusts (VCTs)
These are risky investments, so not for the faint hearted or for any more than a small amount of your portfolio; you should get independent advice if you are unsure whether they are suitable for you. Typically, they invest in small companies on your behalf. These companies are either not listed on the stock exchange or are listed on AIM (a ‘junior’ stock market). You can start from a few thousand pounds right up to £200,000 per tax year.
You can get tax relief of 30% on up to £200,000 per tax year if you buy new eligible shares and keep them for at least five years. You also won’t have to pay capital gains tax when you sell the shares. However, unlike ordinary shares or funds, they can be hard to sell and some have performed very badly over the last few years.
There are lots of ways for you to hold onto more of your profit and make sure less of it disappears in tax, but it is vital to make sure you feel comfortable with the investments before you take the plunge and remember, as with all investments, values can fall as well as rise and you could get back less than you invest.
TIP: Don’t forget tax rules can change and their impact on you depends on your personal circumstances.
Sarah Pennells of SavvyWoman.co.uk
The opinions in this article are those of the author and not necessarily those of SmartWoman and Barclays Stockbrokers.
The price and value of investments and their income fluctuates: you may get back less than the amount you invested. You should bear in mind that how an investment has performed in the past is not a guide to how it will perform in the future. If you are in any doubt about investing in funds, you should consult your financial adviser.