If you’re a higher-rate taxpayer, then you may know the feeling of a receiving a hefty tax bill at the end of the tax year, or seeing your pay cheque significantly diminished.
You’ll also likely face high tax rates on both capital gains and dividend income, impacting your investment returns. Therefore, it’s no surprise that tax-efficiency is a key part of financial planning.
Employing the help of a professional financial planning services is arguably the best way to ensure that you’re investing with tax-efficiency in mind. But we’ll also take a look at some the ways that you can reduce your tax liabilities, through choosing the right type of investment. Remember, the value of investments can go down as well as up, and you may get back less than you invested.
One of the most common strategies to accumulate wealth through savings, and in a tax-efficient way, is to make the most of your pension. The main benefit of investing in a pension wrapper, is that the growth of your funds is free of Income Tax, Capital Gains Tax (CGT) and Inheritance Tax.
Furthermore, your pension contributions are subject to tax relief, rewarded by the government. The tax relief you receive is in-line with the highest rate of income tax you pay. For example, if you pay the higher-rate income tax, then you’ll receive 40% tax relief. Likewise, additional-rate taxpayers will receive 45% tax relief on their pension contributions.
If you contribute to a Self-Invested Personal Pension (SIPP) for example, when you reach retirement age and wish to withdraw from your pension savings, 25% of the funds can be taken completely tax free, with the remaining 75% taxed based on the relevant income tax rate.
As a higher earner, you should also take into consideration the Annual Allowance for pension contributions, as well as the Lifetime Allowance. The Annual Allowance is the maximum amount pension savings you can accumulate each year, which benefits from tax relief.
For the tax year 2021/2022, the Annual Allowance is £40,000, or your salary for the tax year, whichever is lower. However, if you’re a high earner then your Annual Allowance will be tapered — if you have an adjusted income of more than £240,000 per year and a threshold income of more than £200,000 per year.
For every £2 of your adjusted income which goes over the £240,000 limit, your annual allowance for the tax year reduces by £1. The minimum reduced annual allowance you can have in the present tax year is £4,000.
The Lifetime Allowance is the total amount in your pension pot that you can hold without tax liabilities. At present, this is £1,073,100. You may wish to consult with a professional financial or pension adviser if you believe that you’re reaching the limit of the Lifetime Allowance.
Individual Savings Accounts (ISAs)
Another common way to invest tax-efficiently, and arguably the simplest way, is through an ISA. There are four types of ISA:
- Stocks and Shares;
- Innovative Finance;
- And Lifetime
Again, the growth of your funds is completely tax free, including capital gains, dividend income, and any interest accumulated.
ISAs are also flexible investment vehicles, meaning that you can access your money at any time, and any withdrawals are without tax implications. However, there is a maximum you can save within a tax year, and for 2021/2022 this totals £20,000.
Your financial plan will be unique and individual, depending on your personal circumstance. It may be the case that some tax-efficient investments may not be suitable for you, or turn out to be quite complex.
As previously mentioned, it’s therefore worth seeking out expert financial planning advice before investing. This can often provide you with a bespoke plan to suit your needs and requirements, and leave you rest assured about your financial future.