In the UK, there is a wide range of tax efficient structures to consider when considering how best to plan. For a brief outline description of the main structures currently available select one of the following:
- Individual savings accounts (ISAs)
- ISA transfers & re-registrations
- Interest from savings
- Dividend income
- Junior ISAs
- Occupational or public service pension schemes
- Personal pensions
- Limits on tax relief
- What is a VCT?
- What is an EIS?
ISAs are tax efficient savings and investment accounts. They can be used to save cash, or invest in stocks and shares. The maximum that can be put in to an ISA is £11,520 in the tax year, up to £5,760 of which can be saved in cash.
You don't pay any tax on the interest or dividends you receive from an ISA and any profits from investments are free of Capital Gains Tax. But this does mean that you can't use losses on ISA investments to reduce Capital Gains Tax on profits from investments outside the ISA.
ISA allowances can also be used as follows:
If you have money saved from a previous tax year you can transfer or re-register some or all of the money from an existing cash or stocks and shares ISA without this affecting your annual ISA investment allowance or the tax privileges.
- if you pay tax at the basic rate, outside an ISA you would usually pay 20 per cent tax (2013-14) on your savings interest
- if you pay tax at the higher rate, outside an ISA you would usually pay tax at 40 per cent on your savings interest
- if you pay tax at the additional rate, outside an ISA you would usually pay tax at 50 per cent on your savings interest
- if you pay the 'saving rate' of tax for savings, outside an ISA you would pay tax at 10 per cent on your savings interest
- if you're a basic rate taxpayer inside or outside an ISA you pay tax at 10 per cent on dividend income; this is taken as a 'tax credit' before you receive the dividend and cannot be refunded for ISA investments
- if you're a higher or additional rate taxpayer you would normally pay tax on dividend income at 32.5 per cent or 42.5 per cent; in an ISA you won't get back the 10 per cent dividend tax credit element of this, but you will save by not having to pay any further tax
You do not have to pay any Capital Gains Tax on gains from an ISA. (But losses on ISA investments can't be used to reduce Capital Gains Tax on gains from investments outside the ISA.)
Junior ISAs are long-term tax efficient savings accounts especially for children, launched in 1 November 2011 for any child under 18, living in the UK, who does not have, or were not eligible for a Child Trust Fund (CTF) account.
Like ISAs, you can use them to save cash or invest in stocks and shares. You can save up to £3,600 a year in a Junior ISA and you won't pay any tax on the interest or dividends.
For those with child trust fund, following the consultation currently underway, it is expected that a transfer to a Junior ISA will be allowable, to access lower costs and wider investment choice.
National Savings and Investments offer a risk free way of saving and investing as these accounts are backed by the Treasury.
Tax-free savings and investment products from National Savings and Investments currently include:
- Cash ISA - for savers aged 16 or over
- Fixed Interest and Index Linked Savings Certificates - for savers aged seven or over
- Children's Bonus Bonds - can be invested for five years on behalf of children aged under 16
National Savings and Investments also issue Premium Bonds. These bonds do not pay interest, the prizes however are tax free.
The Government encourages you to save for your retirement by giving you 'tax relief' on pension contributions. Tax relief reduces your tax bill or increases your pension fund.
When you retire, providing your own pension scheme rules allow, you can usually take up to 25 per cent of your pension fund as a tax-free lump sum. Your regular pension income is then taxed in the same way as the rest of your income.
You can save as much as you like into any number of pensions - and get tax relief on contributions of up to 100 per cent of your earnings each year, subject to an upper 'annual allowance'. (Savings above a separate 'lifetime allowance' will be subject to tax charges.
The Government encourages you to save for your retirement by giving you tax relief on pension contributions. Tax relief reduces your tax bill or increases your pension fund.
The way you get tax relief on pension contributions depends on whether you pay into an occupational, public service or personal pension scheme.
Usually your employer takes the pension contributions from your pay before deducting tax (but not National Insurance contributions). You only pay tax on what's left. So whether you pay tax at basic, higher or additional rate you get the full relief straightaway.
However, some employers use the same method of paying pension contributions that personal pension scheme payers use.
If you are a GP or dentist and contribute to a public service scheme you are taxed as self-employed for part of your earnings so should claim tax relief through your Self Assessment tax return.
You pay Income Tax on your earnings before any pension contribution, but the pension provider claims tax back from the government at the basic rate of 20 per cent. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot.
If you pay tax at higher rate, you can claim the difference through your tax return or by telephoning or writing to HM Revenue & Customs (HMRC). If you’re an additional rate taxpayer you’ll have to claim the difference through your tax return.
If you don't pay tax you can still pay into a personal pension scheme and benefit from basic rate tax relief (20 per cent) on the first £2,880 a year you put in. In practice this means that if you pay £2,880 the government will top up your contribution to make it £3,600. There is no tax relief for contributions above this amount.
You can put money into someone else's personal pension - like your husband, wife, civil partner, child or grandchild's. They'll get tax relief added to it at the basic rate, but this won't affect your own tax bill. If they've got no income, you can pay in up to £2,880 a year - which becomes £3,600 with tax relief.
If the pension scheme rules allow it you may also be able to put money into someone else's occupational or public service scheme. You'll not get tax relief on your contribution but the other person can get relief either through their tax return or by making a claim to HMRC by telephone or letter.
You can save as much as you like into any number and type of registered pension schemes and get tax relief on contributions of up to 100 per cent of your earnings (salary and other earned income) each year, provided you paid the contribution before age 75. But the amount you save each year toward a pension from which you benefit from tax relief is subject to an 'annual allowance'. The annual allowance amounts for the current and previous two tax years are shown below.
You pay tax on any contributions you make that are above the annual allowance – currently £50,000 per fiscal year. It is also possible to carry forward unused relief from the three previous fiscal years if your contributions were under the £50,000 mark during the years in question. From April 2014, the allwance will reduce to £40,000, so if you are looking to maximise pension contribution, it may be best to do so this year.
The pension fund doesn't pay tax on any capital gains or investment income.
Also, when you retire or chose to take your pension benefits you can take up to 25 per cent of it as a tax-free lump sum, provided your pension scheme rules allow it, and your total savings are within the 'lifetime allowance' for the year in which you take your benefit.
Suitable investors willing to take a high risk can put capital into smaller start-up companies through venture capital trusts (VCTs) or enterprise investment schemes (EISs) - in return for a variety of attractive tax breaks. VCTs were launched in April 1995 and EISs came into being in January 1994.
VCTs aim to make money by investing in new share issues. The underlying companies tend to consist of unquoted companies those traded on the Alternative Investment Market AIM - the stock market for small and young companies - and those traded on PLUS Markets formerly Ofex the off-exchange trading facility for even smaller companies.
The key criteria for investing through a VCT are as follows:
- UK Resident age 18 or over
- Investor Limit £200,000 per person per tax year
- 30% Income Tax rebate on cost of investment provided VCT shares are held for five years and investor has paid this amount of tax
- No liability to higher rate tax on dividends
- No tax realised on gains or CGT on disposal
- The gross assets of the VCT must be less than £7million. After April 5 this will increase to £15Million
- Companies must have no more than 50 full-time employees, increasing to fewer than 250 after 6th April 2012
- Companies must have no more than 50 full-time employees, increasing to fewer than 250 after 6th April 2012.
From April 2012, companies can raise up to £15 million via venture capital schemes in any 12 month period. Certain trades are specifically excluded, e.g. farming, property development, hotels, nursing homes, banking, insurance and businesses earning from Feed in Tariffs for solar and wind electricity production.
An EIS is an investment in a single company which is unquoted privately held. EISs were introduced to replace a broadly similar regime the Business Expansion Scheme that had been originally introduced in 1981. In common with the rules governing VCTs, EIS companies must have no more than 50 employees and raise no more than £2 million in a 12 month period.
EISs should not be entered into without careful forethought however as they are high risk and highly illiquid you can’t easily get your money out. There is no standard mechanism in place through which individual investors can sell unquoted EIS shares, which means it may be difficult or even impossible to sell them.
The key criteria for EISs are as follows:
- UK Resident age 18 or over
- Investor Limit £200,000 per person per tax year
- A statutory tax incentive to encourage private investment into smaller UK companies
- 30% of the cash investment is deductible from your tax bill Can be used to defer capital gains from previous three years and current year
- Need to be held for a minimum for three years to qualify for tax exemptions
- Might be suitable for wealthier clients as part of their small business investments within a diversified portfolio
- Some EIS invest in a single business and so are less diversified than VCTs
- Exempt from Inheritance Tax if held more than two years