Tax-efficient investing

When it comes to maximising your investment returns, picking the right investments is only part of the story, albeit a very important part.  You want to minimise your charges and that includes the amount of money you hand over to HMRC. 

At the same time, you want to exercise a bit of caution about this, since it is far from unknown for HMRC to go after schemes which were believed to be legal and then pursue those involved with them for taxes they didn’t know they owed.  As a rule of thumb, therefore, you want to stick to mainstream options, which have at least some degree of government approval and use them judiciously.

SIPPs and ISAs

Pensions have long been known for their tax-friendly nature, but up until the “pensions freedoms” changes of 2015, the benefits of tax relief had to be set against the need to buy an annuity.  Now, however, there is much more flexibility in how pension funds can ultimately be used and they can even be passed on from one generation to another.  There are, however, still limits on when they can be used, so they may not be the right choice for younger people investing for specific life goals, such as the deposit on a property. 

For completeness, the Lifetime ISA is intended to be used to save either for a first-time home purchase or for retirement.  It may, however, not be the best route for either and so it is advisable to get professional advice before deciding whether or not it’s right for you.

SIPPs and ISAs are not really investment vehicles themselves, they are tax-friendly wrappers for other investment vehicles.  In an ideal world, you would put all of your investments behind these protective covers, but if you have a larger portfolio, then the chances are that you’re going to have to pick and choose. 

As a rule of thumb, you generally want to use these tax shelters for the investments which have the highest expected rate of return (e.g. equities and REITs) as these will typically be subject to the highest tax penalties.

Venture Capital Schemes

Currently, tax-efficient venture capital schemes come in three flavours, the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) and Venture Capital Trusts (VCTs).

The basic idea behind all three is the same.  Investors provide funding for younger (and hence riskier) businesses, essentially the sort of businesses which would often struggle to be accepted by mainstream lenders.  In exchange, they get the potential for investment returns plus tax relief. 

Both the EIS and the SEIS offer a choice of managed or direct investment but VCTs are always managed.  All three schemes have limits on how much you can invest and how long you can hold investments.  As always, these can change over time so always check the current rules.

Venture capital schemes are definitely not for everyone, but they can be more accessible than you might think, especially the SEIS and VCTs.  They may be of particular interest to investors who have in-depth knowledge of an up-and-coming industry sector and hence are in a strong position to identify the companies which have real prospects and eliminate the ones which look like they don’t actually stand a realistic chance of getting anywhere.

Leaving well alone

Last but definitely by no means least, remember that taxes are generally triggered in response to an event.  Sometimes, you will have little to no control over the events which trigger taxes, the current situation being a good example of this, but many times you do.  In particular, you choose whether or not you take dividends as income or reinvest them and you choose when you buy and sell investments.  Choose wisely!