Tax efficient investments for higher rate taxpayers are now essential following last year’s Autumn Statement.
As a reminder, the Chancellor announced a series of cuts to tax allowances such as:
- Dividend allowance, £2,000 to £1,000 and then £500 in tax year 2024/25.
- Capital Gains Tax allowance, £12,300 to £6,000 and then £3,000 in tax year 2024/25.
So, investing in a general investment account has become a lot more expensive, especially for higher rate taxpayers.
Paying more tax means less investment return which ultimately means your retirement could be delayed as you need to save more.
Thankfully there are still tax efficient investments for higher rate taxpayers that should be used first before investing in anything else.
Simple vs complex tax efficient investments for higher rate taxpayers
One thing to remember though when it comes to making tax savings is that you never want to lose sight of your ultimate investment objective.
Just because a particular investment product offers some great tax savings you still need to be confident in the underlying investment strategy of the product.
When it comes to tax efficient investments for higher rate taxpayers there are the simple options that have always worked and do what they say on the tin.
Then there is the complex and potentially more risky options.
Products like Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs) will be marketed as ideal tax efficient investments for higher rate taxpayers as huge tax savings can be made.
But there’s a catch.
Quite often these types of products are difficult to sell, you need to hold them for a certain period and the underlying investments are questionable.
I have reviewed many of these types of investments for new clients and have usually found that the clients end up making a loss even after factoring in the tax savings.
Most of the time they would have been better off taking the tax hit and just investing in something much more mainstream and simpler.
The three best tax efficient investments for higher rate taxpayers
The following products are not as exciting as some of those mentioned above and you most likely have already heard of them, but they are great tax efficient investments for higher rate taxpayers.
#1 – Pension
The humble pension can send some to sleep but as tax efficient saving and investing go this is probably the best tool out there.
For a start you will get tax relief up to your marginal rate of Income Tax.
For example, if you contributed £16,000 to a pension you would receive a top up of £4,000 from the government which is your basic rate tax relief.
So, £20,000 will then sit inside your pension.
As a higher rate taxpayer, you can claim a further £4,000 via your tax return.
So, a £16,000 pension contribution has earned you £8,000 in tax savings.
Or another way to look at it is a £20,000 pension contribution only actually costs you £12,000.
Yes, pensions face taxes when you eventually withdraw from them, but today’s pension flexibility rules mean you can be very clever in how you withdraw to ensure your taxes are kept to a minimum.
Now, there are limits on how much can be contributed to a pension and you may already be hitting the Annual Allowance however don’t forget your partner’s and children’s pensions.
You can still contribute to someone else’s pension and they will still benefit from tax relief.
It’s especially a good idea to boost your partner’s pension if it is significantly lower than yours as it will help with tax planning in retirement and making use of withdrawal allowances.
#2 – ISA
You’re probably familiar with ISAs via your bank account but you can also invest with an ISA.
You can hold a cash and stocks and shares ISA in the same year, but the overall total contribution can’t be more than £20,000.
ISAs are the ultimate simple product.
There is no upfront tax relief like pensions but what you earn inside the ISA is all tax free. So, you don’t need to worry about dividend taxes and Capital Gains Tax.
Also, there is no tax to pay if you withdraw from your ISA at any time.
Again, if you are already maxing out your ISA consider contributing to your partner’s ISA or even an ISA for your child.
A Lifetime ISA is a great way to help children save for their first home as the government gives you a 25% bonus on top of each contribution. The annual contribution limit for a LISA is £4,000 which also counts towards your normal ISA allowance of £20,000.
#3 – Offshore investment bond
Now this type of product is a little bit more complex and can take a while to get your head around, but it is a viable option if you have maxed out your pensions and ISAs.
Essentially, you invest a lump sum into an offshore investment bond and can usually choose the same underlying investment strategy as your pension and ISA.
The investments will grow pretty much tax free.
When it comes to withdrawals there is a fiddly tax calculation that needs to be done and it will depend on how much gain you have made compared to what you originally invested. You get a form of allowance though for the number of years you have held the bond.
A great way to use an offshore investment bond is if you want to invest a large amount of capital and you are happy to give some of this to your kids in the future.
You can assign segments of a bond to your children and use their tax rates to cash money in.
Ultimately, when it comes to tax efficient investments for higher rate taxpayers you need to remember to choose an appropriate underlying investment strategy. We would recommend an evidence-based approach. Something that has been tested using over 100 years of capital market data and has always worked, not something working just now.
You don’t want to blow all your tax savings on poor long term investment returns.
If you would like a more detailed overview of the tax efficient investment options available to you and how having the right investment strategy can mean retiring with freedom then please get in touch for a free no obligation 15-minute call. We would be happy to review your position, explain where you stand and what you need to do to get the outcome you desire. We have created hundreds of happy retirements over the years. This could be you too.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.