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Tax efficient investing

Tax efficient investing

When deciding where to invest your money it's important to consider any potential tax that you may have to pay on your investment returns.

Please remember the value of investments and any income can go down as well as up and you may get back less than you invest.

Being aware of tax implications will help you to make an informed decision about where to invest your money, and to choose the most tax efficient investments for your circumstances.

One of your investment goals for example, might be to provide yourself with a future income stream. You can earn a certain amount of money each year before paying any tax - this is called your personal allowance, and the amount you pay will depend on your personal circumstances. Any income you receive above your personal allowance may be subject to tax.

Tax on investments

There are three main types of tax that you need to be aware of when considering investments:

  • 1.Income Tax
    Your investment may provide you with regular income in the form of interest or dividends. Any tax you have to pay on this income will effectively reduce your investment return.
  • 2.Capital Gains Tax
    Capital Gains Tax is a tax on the profit when you sell (or 'dispose of') an asset including some types of investment. Most people have an annual Capital Gains Tax exemption of £11,100 in the 2016/17 tax year. If you're selling an investment and your profit exceeds this limit you may need to pay Capital Gains Tax (unless your investment sits within a tax-efficient ISA)
  • 3. Inheritance Tax
    Most types of investments and savings you hold will form part of your estate when you die and may therefore be subject to Inheritance Tax

Income Tax

Most people are used to paying income tax on money they earn from working or receive from pensions. Income received from savings and investment products may also be subject to Income Tax.

It's worth understanding which products are taxed in this way because if you're close to the threshold of a tax band, income from an investment could push you into a higher tax bracket and mean you pay a higher rate of tax.

Some products are taxed differently so if you're unsure, it is worth speaking to a Financial Consultant.

You may need to pay Income Tax on any savings income you receive. This includes:

  • interest from bank or building society accounts
  • interest on National Savings & Investments products
  • income from government or corporate bonds
  • interest distributions from unit trusts or open-ended investment companies (OEICs) that invest mainly in interest-bearing assets (such as gilts and corporate bonds)

Personal Income Tax allowances for earned income and savings income

Tax rates and thresholds  Tax year 2016-2017  Tax year 2017-2018 
 Personal Allowance (0%)*  £11,000  £11,500
 Basic Rate (20%)  £11,001 - £43,000  £11.501 - £45,000
 Higher Rate (40%)  £43,001 - £150,000  £45,001 - £150,000
 Additional Rate (45%)  Over £150,000  Over £15,000

*If your income exceeds £100,000, your personal allowance is reduced by £1 for every £2 income above this limit.

Income Tax on Savings

Since 6th April 2016 basic rate tax payers don't have to pay tax on the first £1,000 of savings income they receive each tax year (this is known as the personal savings allowance). Higher rate tax payers don't have to pay tax on the first £500 of savings income received each tax year. Additional rate tax payers don't have a personal savings allowance.

You may also have to pay Income Tax on any gains you make under policies of life insurance (such as Investment Bonds). A liability to Income Tax may, for example, arise if you make a full or one-off withdrawal or if you take regular withdrawals. As gains on life insurance policies are treated as savings income, you can offset any personal savings allowance to which you are entitled.

Income Tax on dividends

Income received from some types of investments in the form of dividends can be subject to Income Tax at the special dividend rates. The rates of tax you pay on dividend income are based on where the income sits within the different tax bands. Since April 2016, the first £5,000 of dividend income received is free from tax for most individuals and the remainder is taxed at incremental rates.

Level of Income Tax on dividends based on your Income Tax band for the 2016-2017 tax year

Tax rate band  Tax rate on dividends over £5,000 
 Basic rate (and non-taxpayers)                         7.5%
 Higher rate                    32.5%
 Additional rate                    38.1%

The following investments may pay dividends:

  • Shares you own in companies
  • Investment trusts
  • Unit trusts and Open Ended Investment Companies (OEICs) that invest mainly in shares

Individual Savings Accounts (ISAs)

An ISA is a type of savings account with tax advantages. ISAs are sometimes called 'tax wrappers'. This means that the ISA is wrapped around the investment you have in it so you pay less or no tax. The government sets how much you can invest into an ISA in each tax year.

Any income (including interest and dividends) from investments held within an ISA is not subject to Income Tax.

Utilising your annual tax free ISA allowance can be useful as a means of sheltering your investments from tax and therefore reducing the impact of tax on your potential investment returns.

There isn't any personal liability to pay tax on income or capital gains from investments held within ISAs and you don't need to declare the income or gains on your tax return.

Capital Gains Tax

Capital Gains Tax (CGT) is a tax on the profit when you sell (or 'dispose of') an asset that has increased in value. It applies to many investments and assets such as:

  • shares you own in companies
  • investment trusts
  • second properties or 'buy to lets'
  • unit trusts and OEICs

It is the gain you make that is taxed rather than the overall value of the item you are disposing of. Disposing of an asset can include:

  • selling it
  • giving it to somebody else
  • swapping it

You only have to pay Capital Gains Tax on your overall gains above your tax-free allowance (called the Annual Exempt Amount). Any gains made above this amount would be subject to Capital Gains Tax.

Capital Gains Tax Rates & Allowances for the 2016-2017 tax year

Annual exemption amount   £11,000 for individuals 
Standard capital gains tax rate  10% (18% on residential property - other than your main residence)
 Higher capital gains tax rate  20% (28% on residential property - other than your main residence)
 The rate (or rates) of CGT you may pay is based on your position within the income tax bands

Different investment products can have different implications for your potential CGT liability, so it is important to seek advice before investing. It is advisable to speak to a Financial Consultant about CGT when planning your investments as this is a complex subject.

Inheritance Tax

Pension products can offer advantages in terms of IHT planning when saving for retirement. But one of your investment goals might be to make additional savings for your retirement. You should remember that any money you have in your bank, building society, or savings and investments accounts usually forms part of your estate.

This means that your beneficiaries may be liable to pay inheritance tax (IHT) on them in event of your death.

The IHT nil-rate band, for the 2016/17 tax year is £325,000. Assets over this amount could be taxed at 40%. However, if you are passing assets to your spouse (or certain other exempt beneficiaries including charities) these are exempt from IHT and do not use up any of your nil-rate band.

Any unused nil-rate band may be claimed by your surviving spouse's executors on their death. This means that there is, potentially, £650,000 that can pass free of IHT on the second death.

From 6 April 2017, the introduction of an additional nil-rate band of £100,000 (rising to £175,000 by 2020/21) could give you an extra allowance to be used when your home is passed on, upon your death, to direct descendents such as your children or grandchildren. This is called the residence nil-rate band and can be transferred to your surviving spouse or civil partner if it isn't used up on your death.

This means when added to the existing £325,000 nil-rate band, a couple will eventually be able to leave £1 million without paying inheritance tax by 2020.

This is a complex area for planning how you wish to leave your legacy, so it is important you understand the risks and seek advice if you are unsure. Your Wesleyan Financial Consultant can help you to understand any tax implications associated with your investment choices.

We understand that your investment goals and financial circumstances may change over time - that's why your Financial Consultant will offer you the option of holding an Annual Financial Review.

This information is based on our current understanding of legislation. Legislation and tax treatment can change in the future.

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