For investors, keeping hold of more of the gains they have worked hard to build is just as important as choosing the right assets in the first place.
A straightforward way to protect those returns is to make sure your portfolio is arranged as tax efficiently as possible.
The key taxes most private investors need to keep on their radar are capital gains tax, or CGT, on profits from investments, dividend tax on income paid by shares and funds, and income tax on interest from bonds.
For many savers, the first line of defence will be pensions and stocks and shares Isas. Both are powerful tax-saving investment wrappers, and in practice, plenty of people will benefit from using a combination of the two.
Deciding which to focus on first will depend on factors such as your age, your income, your tax position and how soon you expect to access the money.
However, pensions and Isas are not the only tools available. With some careful financial planning, investors can reduce the amount lost to HMRC and potentially improve long-term returns. Here is what you need to know.
A stocks and shares Isa remains one of the most important tax-efficient investment options available to savers
Tax on investments
Capital gains tax applies to investment profits above the £3,000 annual allowance, with basic rate taxpayers charged 20 per cent and higher or additional rate taxpayers charged 24 per cent.
Dividend tax is charged at 10.75 per cent, 35.75 per cent and 39.35 per cent for basic, higher and additional rate taxpayers respectively. There is an annual £500 dividend tax allowance.
Income tax at 20p, 40p and 45p, is charged on each pound of interest from savings and bonds, depending on your tax band. An extra 2p will be added to all these rates from April 2027. There is a tax-free personal savings allowance of £1,000 for basic rate taxpayers and £500 for higher rate taxpayers. Additional rate taxpayers get zero allowance.
Pension – £60,000 a year
A pension is probably the most tax efficient way to invest, as contributions qualify for income tax relief and investment profits and dividends are tax-free.
Basic rate tax relief is automatically added to contributions, boosting them by 25 per cent. Higher rate taxpayers can claim their extra tax relief via a tax return or by writing to HMRC.
You can pay up to £60,000, or as much as you earn, into a pension each tax year but that figure includes the basic rate tax relief automatically added and any employer contributions.
The allowance resets each tax year, and you can carry over unused annual allowance from the last three years.
Very low and high earners have different limits. If you earn less than £3,600, you can get tax relief on up to £3,600 of pension savings each tax year. If you earn more than £200,000, the annual allowance tapers down.
Those who have already accessed a defined contribution or private pension get a reduced annual allowance of £10,000.
Investments grow tax-free while in the pension wrapper, which combined with tax relief makes pensions a powerful long-term investing tool.
However, pensions are taxed when you take money out. The first 25 per cent is tax-free (up to £268,275), with the rest treated as taxable income.
The main downside of a pension is that you generally can’t access your pot until 55 – and that age is due to rise to 57 in April 2028. So, if you’re a younger investor, you may not be able to withdraw money for decades.
You can invest via a workplace scheme or a self-invested personal pension (Sipp) with an investing platform. Employers will also contribute to a workplace pension, boosting your pot further.
Isas – £20,000 a year
A stocks and shares Isa is genuinely tax-free. There’s no tax on investment profits, dividends or withdrawals, and you won’t have to worry about filing a tax return to report gains or income on money drawn from the Isa.
For savers, a cash Isa offers a similar haven, with all interest earned tax-free and no tax on withdrawals.
A deal this good obviously comes with a limit and you can pay up to £20,000 into Isas each tax year. This is a use it or lose it affair and you cannot carry over unused allowance from previous years.
An Isa can be accessed at any age, unlike a pension. But the downside compared to a pension is that payments into an Isa come from post-tax income, with no tax relief.
> Best stocks and shares Isas: Read our round-up of the top platforms
Use your partner’s allowances
To maximise your tax-efficient investing, consider your spouse or partner’s Isa allowance, meaning a couple can shelter £40,000 in Isas each tax year.
The same principle applies to pensions. Even if your partner doesn’t work, you could still pay £2,880 annually into their pension. Tax relief bumps that up the total to £3,600.
Be aware that if you are a higher earner who has not used their whole allowance, this would mean forgoing more tax relief on your own contributions. But a benefit of keeping pensions more evenly balanced can come in retirement.
Katherine Waller, co-founder of wealth management firm Six Degrees, says: ‘The mistake we see is couples who build up pension wealth almost entirely in one person’s name. In retirement that person then has to draw it all themselves and can easily tip into higher rate tax, while their spouse’s personal allowance and basic rate band go largely unused.’
Make the most of your CGT-free allowance
The annual CGT allowance means that each year you can make £3,000 in tax-free investment profits.
If you have built up large gains outside of an Isa or pension, you could sell some of your investments each year up to this amount. You can then reinvest in an Isa or pension, if your allowance allows.
Married couples can gift assets to each other capital gains tax-free. So, again, you could make use of two allowances, doubling CGT-free gains to £6,000 per tax year and tax-free dividends to £1,000.
This is one of the most underused tax-planning tools for couples, believes Andrew Prosser, head of investments at InvestEngine.
He says: ‘For couples where one partner isn’t working or earns much less, this alone can be worth hundreds or even thousands of pounds a year in tax saved.’
Use children’s allowances
Consider paying into a junior Isa or junior Sipp for your children or grandchildren. Up to £9,000 can be paid into a junior Isa each tax year, and £3,600 including tax relief into a junior Sipp.
Be aware the money belongs to the child and can’t be reclaimed. The child can withdraw from the junior Isa at age 18 but won’t be able to access the junior pension for decades.
This does, however, mean the money will have a long time to grow. If you had saved £10,000 into a junior Sipp by the time your child reaches age ten and it grew by 6 per cent a year after fees, it would be worth £184,000 at age 60.
Gilts
UK government bonds, known as gilts, are increasingly becoming part of conversations about how to hold cash more tax-efficiently, says Tom Cheesman, investment manager at JM Finn.
Cheesman says they are attractive to people, perhaps retirees, who have maxed out pensions and Isas and are looking for stable returns.
This is thanks to capital gains on gilts being tax-free. The mass issuance of low-rate gilts after the financial crisis and pandemic, when interest rates were on the floor, means many can now be bought below face value. If that gilt is held to its end date, the full amount of the face value is paid to investors, generating a capital gain.
Cheesman says: ‘If you buy a gilt below its £100 redemption value and hold it until maturity, the increase in value at redemption is tax-free.’
However, the interest paid by a gilt is taxable when held outside an Isa or pension. Gilts can also fall in value if you need to sell before maturity.
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