Guide to tax-efficient investing

At a glance

• Tax wrappers can provide some protection for your investments from tax
• Investors can use allowances and reliefs to reduce their exposure to Capital Gains Tax and Inheritance Tax
• Pensions can enable investors to save for retirement in a tax-efficient way and avoid the ‘60% tax trap’
• You can move assets into your Individual Savings Account through a 'Bed and ISA', thereby making use of your annual ISA tax allowance
• Professional financial advice can help investors reduce their overall tax outlay
• This guide provides general information on tax-efficient investing and not personalised tax advice

What is a tax wrapper?

When finance professionals talk about Individual Savings Accounts (ISAs) and pensions, they will often use the phrase ‘tax wrapper’. This simply means your money is in an account that ‘wraps’ around your investments or savings to offer some protection from tax, as long as the money stays within these wrappers.

There are three main types of tax that can impact investors:

Capital Gains Tax (CGT): CGT is the tax you are required to pay when you sell or ‘dispose’ of an asset for a profit, or 'gain'. A capital gain is, broadly speaking, the difference between the price you paid for something and the price you sell it for. The tax you pay is on the gain only – not the total sale price.

Income tax: Income tax is levied on most types of income, including on wages and salaries, as well as on interest and dividends from investments and savings.

Inheritance Tax (IHT): When a person dies, the assets they leave behind form their 'estate'. IHT is charged on the estate left, but only if its value exceeds a certain threshold. No IHT is due if the estate is passed to a spouse, a civil partner, or a charity or community amateur sports club. Additionally certain assets may be fully or partially exempt from IHT.

There are different types of tax wrappers – ISAs and pensions are among the most common – and each offer different features and tax advantages.

ISAs

An ISA allows you to save and invest a certain amount of money every year without having to pay tax on any growth in your investments or savings. This amount is known as your ISA allowance. For the current tax year (to 5 April), the ISA allowance for UK residents aged 18 and above is £20,000. You can also invest on behalf of a child under the age of 18 in a Junior ISA tax free.

Stocks and Shares ISAs may be ideal for those who want to put money away for the longer term – at least three years – by investing tax efficiently in financial markets. If your investments held within an ISA grow in value, any gains made will not be subject to CGT. Investment income, such as dividends and interest received within an ISA, is also tax-exempt.

The Lifetime ISA (LISA) could be a good way to save or invest for either your first home valued up to £450,000 or towards retirement. If you are planning on using your LISA for retirement, you can withdraw from it at the age of 60 (and make contributions up until age 50). Those eligible (the first contribution must be made between the ages of 18 and 39) can contribute up to £4,000 per tax year and the government will add a 25% bonus – that's up to £1,000 every year of contribution up until age 50. LISA contributions count towards your annual £20,000 ISA allowance.

A Junior ISA (JISA) can be set up by a parent or guardian for each child under the age of 18, but please note that to open a J.P. Morgan Personal Investing JISA for your child they must be under 16. The parent or guardian, or friends and family, can contribute to the account but only the child can access the money – and only after they turn 18. JISAs have a separate tax allowance of £9,000 per tax year that does not count towards the £20,000 annual allowance for other types of ISAs.

Pensions

A pension is a tax-efficient way to put money aside for later in life, giving you an income for when you retire or cut back on your working hours. In a defined contribution pension, you, your employer, and third party contributors such as your spouse or children, can all contribute towards your retirement savings.

Everyone, whether you’re working or not, is entitled to get basic rate tax relief at 20% from the government when you make contributions to your pension. For example, if you wanted to have a total of £1,000 contributed to your pension, tax relief would mean that you’d only need to add £800, as the government will add £200. You are limited to tax relief on a gross contribution of £3,600 (£2,800 net) if you are not working in the UK or not paying UK income tax.

Tax relief is linked to the highest band of income tax you pay. This means that if you’re a higher-rate or an additional-rate taxpayer you could claim extra tax relief on top of the basic 20%. Higher-rate taxpayers can claim a further 20%, while additional-rate taxpayers can claim an extra 25%. Pension contributions can also help to mitigate against the impact of the so-called '60% tax trap'. If your taxable income is between £100,000 and £125,140, sacrificing salary in favour of pension contributions can prevent this income from entering a higher tax bracket. 

As with ISAs, investment income and gains are tax exempt within your pension. However withdrawals from your pension may be taxable as income.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with J.P. Morgan Personal Investing can go down as well as up and you may get back less than you invest. ISA/JISA/LISA/ Pension eligibility rules apply. With LISAs, government withdrawal charges may apply. Tax rules vary by individual status and may change. This is general information, not personalised tax advice. If you are unsure if a pension is right for you, please seek financial advice.