Tax can be one of the most important yet complicated aspects of investing to consider when trying to build your wealth effectively.
Many investors look for guidance on tax-efficient investing – whether through research, advice, or online wealth management, for example.
We’ve put together this guide to help you understand how tax could impact your investments, and what steps you can take to be more tax-efficient with your approach.
Understanding Tax on Your Investments
When investing in a variety of accounts, it’s important to know how your money might be taxed and how much you could need to pay.
There are two main tax charges you’re likely to run into when investing – Income tax and Capital Gains Tax (CGT).
- Income Tax
Income Tax is a specific tax charge that applies to your annual income. This can cover a range of thing, such as your salary from an employer, some state benefits, rental income, and more.
When it comes to your investments, you may be eligible to pay Income Tax on a certain portion of money you invest in an account.
For example, your personal pension provides an annual allowance of £60,000 for the current 2023/2024 tax year, but any savings contributed above this amount will be subject to Income Tax.
- Capital Gains Tax
CGT is a type of tax that is applied to the profits or ‘gains’ made from selling or disposing of an asset. This can include the gains made from selling a house, shares, or personal possessions, for example.
With CGT, you’re only taxed on the profit made from selling the asset, not the total price you sold it for.
When investing, your money can grow due to successful investments in certain securities. You may be charged CGT on the growth made from these investments with certain accounts.
Investing Tax-Efficiently With Wrappers
One of the most effective ways to invest tax-efficiently is to utilise tax wrappers. These are specific investment accounts that shelter your money from tax, essentially ‘wrapping’ them up to avoid Income Tax or CGT.
There are two main tax wrappers used by investors to grow their wealth effectively:
Investing in a personal pension allows you to grow your savings towards retirement. Every year, you can contribute a certain amount to your pension which is exempt from Income Tax and CGT. At the time of writing, this allowance is £60,000.
This way, you can invest your money annually with the aim to grow a significant amount in your pension pot, without needing to worry about tax impacting your wealth.
When you decide to retire, you can then withdraw this money tax-free to fund the comfortable retirement you’ve always wanted.
Individual Savings Accounts (ISAs) also allow you to invest money tax-free – up to £20,000 a year. This is according to the current ISA allowance.
The difference with an ISA, other than the lower allowance, is that you can withdraw your money at any point tax-free.
You can also invest in four different types of ISAs – cash ISAs, stocks and shares ISAs, innovative finance ISAs, and Lifetime ISAs.
You can use ISAs to build up your savings each year towards specific financial goals, whereas pensions are designed specifically for retirement.
If you want to invest more tax-efficiently, these two tax wrappers are a good place to start, as they provide the potential to build your wealth tax-free towards your goals.
How you go about investing in these accounts will depend on your unique financial situation, and it’s important to craft the right approach that best suits your finances regarding tax charges.
Please note, the value of your investments can go down as well as up.
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