Note: The Lifetime Allowance has reduced from £1.25m to £1.0m. This will be index linked
(CPI) from April 2018. Transitional protection will be introduced for pension rights already over £1m. The material on this page does not currently reflect
Read about the April 2016 Tax Changes
As well as deciding what to invest in, you need to think about how you’re going to hold your investments. Choose a tax-efficient account and you will often be able to keep a higher proportion of any returns you make.
You should always bear in mind that the value of all investments can go down as well as up, so you could lose money, and that tax rules can change in future. What’s more, the benefits you actually derive from favourable tax treatment (such as those given to Individual Savings Accounts (ISAs) and pensions) will depend on your individual circumstances. Your circumstances can change in the future, so it could still be worthwhile using your ISA allowance every year to build up a tax-free pot that you may be glad of later, provided that ISAs continue.
Individual Savings Accounts (ISAs)
If you hold investments in an Individual Savings Account – ISA for short – you won’t pay Income Tax or Capital Gains Tax (CGT) on any returns they make.
Your annual ISA allowance
There are two different types of ISAs available - an Investment ISA, also known as a stocks and shares ISA, and a cash ISA. You need to be a UK resident aged 16 or over to open a cash ISA, or aged 18 or over to open a stocks & shares ISA.
The current annual ISA allowance (tax year 2016/17) of £15,240 can be used fully in a cash ISA, all in an investment ISA or shared between the two. The ISA allowance of £15,240 will increase to £20,000 for the 2017/18 tax year.
ISAs offer excellent tax benefits to UK tax payers. Although the benefit that you actually gain depends on your circumstances.
Investment ISAs exempt you from capital gains tax (a tax on profits, payable when you sell your assets). Outside an ISA you can make £11,100 a year of profits before being liable to pay this tax, so investing through an Investment ISA helps those who are making sizeable gains within one tax year.
Interest earned on cash or interest bearing investments (such as bond investments and interest distributions from funds) held inside of an ISA are not subject to income tax.
Dividends earned inside an ISA are not subject to tax.
The investments held in ISAs, and gains, and income derived from them, do not need to be reported in your tax returns.
The introduction of the tax free Personal Savings Allowance of £1,000 for basic rate tax payers and £500 for higher rate tax payers on interest on savings income this tax year means that cash ISAs in particular are less important for short term savings. Investment ISAs may also be less attractive over the short term following the introduction of the new dividends allowance this tax year, with up to £5,000 of dividend income can be received tax free. However, as any unused ISA allowance cannot be carried forward to a future tax year, and interest rates and dividend income may rise in the future (above the allowances), they still remain an important factor for longer term saving.
Build up a tax-free portfolio
Using your ISA allowance every year could help you build up a large tax-efficient portfolio over time. Although there are limits to the amount you can put into an ISA each year, there’s currently no limit on the total value your ISA can grow to. Keep in mind too that tax rules can change in the future. Because you don’t pay tax on the returns from ISAs, they can be useful for saving for retirement. When it’s time to start making withdrawals from your ISA, you won’t pay any tax on those withdrawals. Keep in mind though that tax rules can change in the future; ISAs might not continue indefinitely.
Your ISA allowance – use it or lose it
Currently if you withdraw cash from your ISA you can’t pay it back in without using up more of your annual allowance. However, Flexible ISA holders will be able to take money out of their ISA and put it back in, without it counting towards their annual ISA subscription limit for the tax year, provided the repayment is made in the same tax year as the withdrawal.
For example, if you withdraw £50,000 from your ISA from 6 April 2016, you’ll need to add it back to your ISA through one or multiple payments prior to 5 April 2017 for it to be covered by the Flexible ISA rule. Not all providers will offer Flexible ISA’s, so check with your provider before making any withdrawals.
Pensions are another tax efficient way to invest. They differ from ISA’s because you benefit from tax relief on contributions you pay in up to certain limits, although 75% of the sums you eventually take from your pension pot will be taxable. Like ISAs, the benefits to you of this favourable tax treatment will depend on your individual circumstances, and the rules around them could change in the future.
When you retire you can take 25% of your fund as tax-free but any more money you take from your pension is taxed as income in the year you take it.
Because a pension is designed to give you an income when you retire you can’t take any money out until you reach the age of 55. That is set to rise to 57 by 2028 and from then on you can draw pensions at the state pension ageless 10 years. Since April 2015 there’s no limit on the amount you can withdraw each year. Pensions offer greater flexibility than ever before in how you draw your benefits. However, if you decide to withdraw large amounts you may face a significant tax bill.
If you’re an experienced investor, a Self Invested Personal Pension (SIPP) lets you make your own investment decisions. So you have greater control over how your retirement savings are invested.
Things to remember
The value of all investments can fall as well as rise, so you could get back less than you started with, and the tax benefits to you offered by ISAs and pensions depend on your individual circumstances and might change in the future. If you’re unsure whether investments are right for you, please seek independent financial and taxation advice.
Capital Gains Tax (CGT) - Capital gains are profits you make when you sell an asset at a higher price than you paid for it. Some assets, such as your principal private residence, most UK government bonds and cars, are exempt from CGT. Every year, UK taxpayers have a CGT allowance, called the annual exempt amount. For 2016/2017, it’s £11,100. You need to pay tax to the extent that your gains (on non-exempt assets) in the year exceed the allowance. The rate at which you pay tax on such gains depends on a combination of your overall income, and the gains. The current CGT rates are 10% or 20%.
It’s always worth thinking about whether you’re making the most of your tax allowances when making your investment decisions. Remember too that tax treatment depends on your individual circumstances and you should seek independent taxation advice tailored to you.
Barclays is not a legal or tax adviser and is not providing you with legal or tax advice. If you need financial advice, or have any queries as to the legal or tax implications of any investment, you should seek independent professional advice.