Too many investors ignore the effect of inflation, which can ravage the true value of money. To make a real return on savings when the Consumer Prices Index is 2.7 per cent, basic rate taxpayers need a return of 3.39 per cent or more. For higher-rate taxpayers, that figure is 4.51 per cent.
Start by keeping cash as tax-free as possible. By using the cash part of an Individual Savings Account (ISA), the money is not subject to any taxation. Another way, recommended by Alex MacLean of Aspire Wealth Management, applies if you are married and one partner is a non-tax payer. The couple should hold cash accounts in the latter’s name.
There is always a strong case for building value in pensions. Most individuals under 75 will receive tax relief on contributions up to £50,000 of their annual earnings. If the full allowance has not been taken in the previous three years, take action before the end of this tax year on 5 April.
“Tax relief at your highest marginal rate is not something you should dismiss lightly,” says MacLean. “However, take time to think where your retirement income will emerge from.”
While there is an initial tax boost to a pension pot, you will be paying tax every year when it pays income. With greater longevity, this could amount to a significant cumulative tax. An alternative strategy would be to sacrifice some of the pension tax relief to fund the full ISA allowance, giving the opportunity to draw income later in the form of dividends and capital. MacLean says: “No further personal or Capital Gains Tax (CGT) liability year-on-year when you retire seems attractive.”
Currently, £11,280 can be sheltered in an ISA, which will rise to £11,520 next tax year. Anyone of 18 years and older can open an equity, non-cash ISA, but it’s vital to keep its performance under review. If you do not have the time, apart from a regular IFA review, make sure the money is consistently supervised through a “fund of funds” approach, such as Margetts Venture Strategy, which has a good geographical spread.
Pensions are not just for those in the world of work. Caitlin Loynd at Save & Invest says stakeholder pensions are a good way for higher-rate taxpayers to help their families. There is no restriction on who can pay the premiums, meaning grandparents can make payments out of income to pass on their wealth. This means up to £3,600 can be paid in for any non-working spouse and every child.
Self-invested personal pension (SIPP) plans are now available at low cost (£100-£200 per annum). Loynd suggests using one to hold tracker funds where the annual cost can be cut from a typical 1.5 per cent to just 0.25-0.5 per cent.
The level of personal allowance – the exempt amount before income tax is paid – rises next year from £8,105 (which would have been £8,285 with indexation) to a helpful £9,440. The extra money should also boost savings.
Tax havens obtained a perhaps justifiable bad press last year but this overlooks the positive effects that can come from tax-incentivised investments. Venture Capital Trusts (VCTs) provide businesses with development capital. In return, investors have a tax cushion as a reward for the risk they take: 30 per cent income tax relief on up to £200,000 plus CGT exemption on disposal of shares and tax-free dividends. You have to hold a VCT investment for at least five years to benefit from the tax relief.
Paul Galloway, of Edinburgh Risk Management, says: “VCT groups, in looking to attract new investors, are concentrating more on the underlying investments and emphasising capital preservation.”
Galloway is also seeing the merger of existing VCTs and new share offers for current ones with proven track records. He says VCT provider, Octopus, is looking to raise about £20 million for its Apollo VCT, which is the merger of four separate VCTs.
“This allows clients to gain exposure to established smaller companies and lessens the overall investment risk,” says Galloway.
He also favours Northern Investment Managers, which has been raising money for two of its well-established VCTs. It already holds 40 investments in a range of different industry sectors which reduces risk for new savers.
“Investing in off-grid solar units via the Ingenious African Solar Fund might be one way to combine tax relief with a social conscience,” says Jeffrey Deans, chairman of the IFA Save & Invest. “These units allow off-grid communities to abandon kerosene as their sole fuel. It allows children to study at night without risking their health, businesses to stay open and enables mobile phones to be charged,” he adds.
Joining an Enterprise Investment Scheme (EIS) is another vehicle, gaining up to 30 per cent tax relief on subscriptions of £500-£1m. Unlike a VCT, it is not regulated or quoted on the stock exchange. It means money is being loaned to a seedcorn project, rather than an already maturing plant.
A newer plan is the Seed Enterprise Investment Scheme (SEIS) where investments of up to £100,000 attract 50 per cent income tax relief. It is also permitted to rollover gains made in 2012-13.