HOW TO BE TAX SAVVY IN THE UK: A FINANCIAL ADVISER'S GUIDE TO MINIMISING PERSONAL TAX BURDENS

The financial services landscape is constantly evolving in the UK. It is sophisticated and fast-paced. One of many benefits that come from using a financial adviser is our ability to distil this complexity and craft tax-efficient financial plans for our clients.

Starting with the basics, we can use a deep understanding of the system to help clients minimise their tax burden and accelerate the accumulation of wealth.

Key to this is our capacity to make the most of tax-wrappers and government sanctioned tax reliefs. Each of these has nuanced benefits so it’s always important to find the right balance.

This simple guide has been put together by the independent financial advisers at Blackmount Private Wealth. It outlines some options you have for investing tax-efficiently.

POPULAR TAX WRAPPERS

Investments are predominantly taxed based on the type of account they are held within. The structure of these accounts means they are often referred to as “tax wrappers” because they wrap around your investment to provide protection from certain tax regimes. Examples of the most common tax wrapper are:

Individual Savings Account (ISA): This type of investment account is only available to residents of the UK. As the name suggests, they can only be owned by an individual, so you can’t have joint accounts with someone else. ISAs were introduced by the government to encourage saving and investing by sheltering the money held within the account from tax. Some of the key features are:

• Tax-free savings.

Any income or capital gains generated within the ISA account are tax-free. That means you don’t have to pay income tax or capital gains tax on interest earned on cash savings, dividends from stocks and shares, or capital gains from investments held within the ISA.

• Contribution limits.

Each tax year, individuals are allowed to “subscribe” up to a certain limit into their ISAs. This limit is set by the government and may vary from year to year.

Recently, the ISA subscription limit has been frozen at £20,000. There are various types of ISA (cash, stocks and shares, lifetime, innovative finance) and you can only pay into one of each type each tax year.

The maximum £20,000 applies across all ISAs. Lifetime ISAs also have more complicated limits and criteria for contributions.

A new “British ISA” has been proposed by the previous government, which may allow more to be paid into ISA accounts that only invest directly into UK focused assets. The government is due to consult on this before they are introduced.

• Flexible investment options.

ISAs offer a range of investment options to suit different investor preferences and risk profiles.

• Accessibility.

Unlike pension accounts, there are no restrictions on when you can access your funds so you can withdraw money from your ISA without penalty.

Some modern ISAs are also “flexible” which means you can put money back in during a tax year without impacting your subscription limit.

• No reporting requirements.

There are no reporting requirements for ISAs because all income and gains generated within the account are tax-free. That simplifies the administrative burden for investors compared to taxable investment accounts (which may require you to submit self-assessments).

• Transferability.

Individuals can transfer existing ISAs from one provider to another without losing their tax-free status.

This allows investors to shop around for better interest rates, lower fees, or different investment options while maintaining the attractive tax benefits.

For example, a cash ISA can be transferred to a new Stocks and Shares ISA allowing you to invest the savings built up rather than accruing interest.

Pensions: A pension is a long-term savings plan designed to provide individuals with income during retirement. Like an ISA, pensions can only be owned by an individual so there’s no way to share the tax benefits with anyone else. Regardless, they are a tax-efficient way to save for retirement. Some key features are:

• Contributions.

  Money saved into a pension can come from various sources, including you, your employer, and family members (or anyone else).

  
  

  Contributions made to a pension attract tax relief from the government at your marginal rate of income tax (or corporation tax if the payment is an employer contribution). The amount that can be contributed into a pension and gain tax relief is limited each tax year to the Annual Allowance – which is £60,000, but restricted to the higher of 100% of your relevant earnings or £3,600.

  
  

  This figure may also be reduced to the Money Purchase Annual Allowance if “flexible” income has been taken from any pension plans, or tapered away if you are a high earner.

  
  

  Unused Annual Allowance from three previous tax years may also be “carried forward” under certain conditions.

  
  

  The rules about tax relief available on pension contributions are complicated so you should seek professional advice about it where necessary.

• Tax benefits. 

  Pensions offer several tax advantages to encourage people to save for their retirement (and hopefully not become dependent on the State in later life).

  
  

  Not only do pension contributions attract tax relief, but the investments within a pension grow tax-free. When you reach the minimum pension age, you can usually take a tax-free lump sum from the pension. Anything beyond this amount is taxed as income via PAYE.

  
  

  Under the “pensions freedom” rules there is a lot of scope to tailor the structure of income/tax-free cash that comes out of your pension, so it’s a good idea to seek professional advice about how best to set up your retirement income.

• Investment options. 

  The money saved into a pension can be invested in a wide range of assets such as stocks and shares, bonds, and commercial property. How the investment portfolio is constructed can be tailored to your individual risk tolerance, investment goals, and time horizon.

• Retirement options. 

  When you reach retirement age, there are several ways to access a personal pension. 25% of the total fund value (up to £268,275) can usually be taken tax-free.

Investment Bonds: As a type of investment product offered by insurance companies, Investment Bonds operate with their own unique tax rules. They’re designed to provide the potential for tax-efficient growth on a lump sum investment over a long period of time. Some key features are:

• Lump-sum investment. Investment bonds require you to invest a single lump sum of money upfront. This is then invested by the bond provider (insurance company) in a diversified portfolio aiming to grow the value of your money over the long term.

  
  

  (See our blog “Navigating investment options” for more about diversification and investment options). There’s usually a selection of mutual funds available for you to choose from.

• Tax treatment. 

  The way Investment Bonds are taxed is unusual. Returns generated within the bond – such as interest, dividends, and capital gains – are tax-deferred. That means you don’t have to pay tax on the returns until certain “chargeable events” happen – including money being withdrawn, the policy maturing, or the “lives assured” dying.

  
  

  When a chargeable gain is made from an Investment Bond, it’s subject to income tax. If the bond is held “onshore” it pays corporation tax on returns made within the investment fund. To reflect the corporation tax that has been paid, you benefit from a 20% tax credit when calculating the tax due.

  
  

  That means further tax only needs to be paid if the gains fall into the higher rate band (or above) when added to your other income in that tax year. The fact that tax is deferred until a chargeable event can lead to more tax being paid at high rates than would have been the case if those gains were assessed each year.

  
  

  To remedy this, “top slicing relief” is given to essentially average it out across the length of time the bond has been invested. The tax treatment is different if the bond was held “offshore” or it was held in trust. Taxation of bonds is very complicated so professional advice should be taken when calculating what tax is due.

• Withdrawals. You can withdraw money from an Investment Bond (if the policy allows) at any time by making either a full or partial “surrender”. These can be tax-free up to a limit each year.

  
  

  5% of the lump sum initially invested can be surrendered each year without paying tax. If withdrawals aren’t taken, any unused part can be carried forward to future years. That allowance also rolls up if it's not used (for up to 20 years so the total can’t be more than the amount paid in).

• Death benefits. As most Investment Bonds are written as life insurance, a small amount of life cover will be paid when the “lives assured” die. This is paid in addition to the investment value. When the last life assured dies, the bond will end and trigger a chargeable event. Any gains will then be taxed. Remember, the taxation rules are complex so take advice on it.

• Tax planning. Although complicated, the tax rules on Investment Bonds can allow high earners to manage their tax position. As the gains are tax-deferred, this gives opportunity to remain invested until your income reduces (i.e., after retirement etc.) and therefore avoid the gains being added to a higher marginal rate of income tax.

Tip: Where you have the financial capacity to do so, a good financial adviser will formulate a plan for you which structures your wealth across the various tax wrappers to maximise the benefits you receive.

BEYOND THE WRAPPERS: EXPLORING ADDITIONAL PERSONAL TAX STRATEGIES

In conjunction with tax wrappers, astute financial advisers will explore further strategies to minimise your tax liability. This might include things like:

Utilising the Capital Gains Tax (CGT) allowances.

Each tax year, individuals have an amount which is exempt from capital gains tax. That means you can realise gains from investments up to this value without paying tax.

Any gains above the annual exemption are taxed according to the CGT rates. The rate of tax paid varies depending on whether the chargeable gains exceed the higher rate threshold and/or the gain was made from residential property.

Additional reliefs such as Business Asset Disposal Relief (previously known as Entrepreneurs Relief) may be also available. Making the most of these allowances can help to structure your wealth as tax-efficiently as possible.

Spousal allowances.

The Marriage Allowance lets you transfer a portion of your Personal Allowance (the amount of income you can receive before paying tax) to your spouse or civil partner.

To do this, the lower earner must normally have an income below the Personal Allowance and the other partner pays income tax at the basic rate (or up to the intermediate rate in Scotland).

This can save you some tax as a couple if one partner earns more than the other. The ability to transfer assets between spouses/civil partners without there being a tax implication can also improve the overall tax-efficiency of your family wealth by allowing the full use of all allowances and reliefs (where available).

Dividend reinvestment.

Simple measures like electing to reinvest dividends received from investments held within an ISA allows for the returns to be compounded tax-free. That can accelerate the overall growth of your wealth and retain the tax efficiencies provided by the ISA wrapper.

THE ART OF TAILORING TAX-EFFICIENT STRATEGIES

Understanding each client’s unique circumstances lies at the heart of tax-efficient wealth management and financial planning. Some factors we consider when crafting personal recommendations are:

Goals and objectives.

Before any planning starts, we need to find out what you are looking to achieve. Distilling this into specific, measurable, actionable, realistic, and time-bound (SMART) objectives and targeting your strategy towards this greatly increases your chance of success.

Risk tolerance.

The amount of risk that you take with investments will drive its performance.

Low risk strategies are less likely to lose money over the short term, but that’s traded off against a lower scope for returns.

Conversely, a high-risk investment has a greater chance of generating large returns but there is a greater likelihood of you losing money.

A good financial adviser will determine how much risk you’re comfortable taking with your money and assess how much risk you need to take to achieve your stated objectives. They’ll also quantify how much you can afford to lose.

Combining these three factors will allow you to take an appropriate amount of risk with your investments. That could be done as a blanket approach or balanced across different tax-wrappers or pots of money aimed at certain objectives.

For example, a young professional might be willing and able to take a lot of risk with her pension fund because it can’t be accessed for decades, and she expects to remain invested into old age. The long time-horizon allows her to ride out drops in the market in search of growth. The same person might only be comfortable taking a more cautious approach with her stocks and shares ISA because she intends to use those funds to purchase property within a shorter timeframe.

Investment time horizon.

When you need to access funds will be considered as part of your investment strategy, it may also have a bearing on how your wealth is structured for taxation.

Money that needs to be spent within a few years probably shouldn’t be invested. It’s therefore likely to be held in cash or cash equivalents (see our blog “Navigating investment options”). These are very low risk assets, so they will only generate small or modest returns. Holding that outside of valuable tax wrappers could therefore prove beneficial (once you account for potential entitlement to reliefs like the Personal Savings Allowance and starting rate for savings).

Other investments.

If you are a high earner and/or have already accumulated substantial wealth, maximising contributions to pension funds and subscribing as much as you can to ISAs is a sensible starting point.

Going beyond these core tax wrappers and exploring more sophisticated investments that reduce your tax position may also be an option.

Government sanctioned schemes such as Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EIS) encourage investment into Britain’s more entrepreneurial businesses. To support these innovative small companies that bolster the UK economy, such schemes offer incentives including upfront income tax relief, tax-free dividends, capital gains tax exemption (or deferral), and Inheritance Tax relief.

You should take independent advice before investing in this type of scheme because they are inherently risky and may experience sharper volatility than shares listed on the main stock exchange, and they can be harder to sell. You should understand the implications of investing in these funds and the relevant criteria for tax reliefs.

Trusts.

A trust is a legal arrangement in which you transfer legal ownership of assets to another party, known as the trustee, to manage and administer.

Trusts can be a powerful tax planning tool and a mechanism to protect family wealth. Although there can be significant benefits to using them, the tax treatment of trusts in the UK us complex and varies depending on the type of trust, the value of assets involved, and potential changes to legislation.

Consulting a qualified professional is important. Trust are not regulated by the Financial Conduct Authority (FCA).

Tip: To get the most out of your wealth, we recommend instructing an independent financial adviser. Doing so will make sure your investment strategy is tax-efficient and aligned to your wider goals. That can provide immense peace of mind.

THE POWER OF COLLABORATION: PARTNERING WITH TAX PROFESSIONALS

UK tax legislation is complex and navigating the intricacies can be difficult – especially if you try to go it alone. Once you start to mitigate tax, your affairs can become complex quickly. Many professionals can spend a lot of time living and working outside the UK, which can impact residency status and entitlement to certain tax advantages. Combining personal financial planning with that of your business may bring in the need for an accountant. Placing money or assets into trust will require a solicitor.

If your tax affairs become particularly complex or your plans enter niche areas to offer you the best outcomes, Blackmount Private Wealth can introduce you to suitably qualified and experienced specialists. We have strong connection with accountants/tax advisers, solicitors, private bankers, etc., who can help you receive the most comprehensive wealth management programme.

Taking a collaborative approach can unlock additional opportunities for tax efficient financial planning, while giving you peace of mind the strategy is watertight.

THE BOTTOM LINE: EMPOWERING YOU THROUGH TAX EFFICIENCY

Mastering the art of tax-efficient financial planning allows independent financial advisers like Blackmount Private Wealth provide exceptional value to our clients.

Minimising the amount of tax you pay by making the most of government sanctioned reliefs and schemes, empowers you to:

• Retain more of your hard-earned money.

• Accelerate the accumulation of wealth.

• Provide a comfortable retirement on the other side.

• Achieve your long-term financial goals with confidence.

Your advisers stay abreast of evolving tax regulations and strategically use the wrappers, reliefs, and schemes available to you. That allows us to be a trusted partner on your journey to financial freedom.

Let’s talk.

IMPORTANT INFORMATION

The value of investments can go down as well as up and you may not get back the full amount invested. The past is not a guide to future performance. Past performance may not be repeated. Changes in the rates of exchange may have an adverse effect on the value or price of an investment in sterling terms if it is denominated in a foreign currency.

It is important to take professional advice before making any decision relating to your personal finances. Information in this blog is based on our current understanding of taxation and can be subject to change. It does not provide individual tailored investment advice and is for guidance only. Some rules may vary in different parts of the UK; please ask us for details. We cannot assume legal liability for any errors or omissions this blog may contain. Levels and bases of, and reliefs from taxation are those currently applying or proposed and are subject to change; their value depends on the individual circumstances of the investor.

The information contained within this blog is for information only purposes and does not constitute financial advice. The purpose of this blog is to provide technical and general guidance and should not be interpreted as a personal recommendation or advice.

The Financial Conduct Authority does not regulate some forms of tax advice, or trusts.