No-one wants to see the tax-man take an unduly large slice of their hard-earned money. It’s important therefore that investors maximise the tax-free options that are available to them.
Tax regimes, in relation to savings and investments, differ from country to country. I live in the UK so this article focuses specifically on the tax-free options that are open to UK investors. However, it is likely that similar instruments will be available in other jurisdictions, so hopefully the options listed in this article will enable you to investigate similar options in your country.
Options for maximising your tax-free investments:
Option 1: Take out a pension
Everyone should have a pension and the beauty of pensions is that they are a tax efficient device. Basic rate taxpayers get 22% tax relief on pension contributions, so for every 78 that they invest, the government contributes 22, bring it to 100.
Option 2: Maximise your tax free basic savings allowance, via a Cash ISA.
ISA stands for Individual Savings Account. ISAs were introduced by the UK government in 1999, and provide a means for people to get a tax free return on their savings. Up to now, you’ve been able to invest up to 3,000 per tax year into a Cash ISA. However, from April 2008, this yearly limit is being increased to 3,600. Most financial advisers recommend that you keep some money back in instant access savings accounts, so it makes great sense to maximize your ISA allowance each year. (Note: You can only have one Cash ISA per year)
Option 3: Maximise your tax-free investment in shares, via a Shares ISA.
As well as being able to have a Cash ISA, you can also take out a Shares ISA. The total yearly amount that you can invest into ISAs is 7,000 per year. Therefore, if you’ve taken out a Cash ISA with a 3,000 limit, then you can invest an additional 4,000 into a Shares ISA. Or alternatively, if you don’t have a Cash ISA, you can invest the full ISA 7,000 allowance into your shares ISA. A little bit complicated but definitely worth making the most of.
By utilizing the Cash and Shares ISA allowances, you can invest up to 7,000 per year without having to pay any tax on those investments. This should meet the needs of most investors. However, there are still some other options if you have more to invest.
Option 4: Maximise your partner’s ISA allowance.
If you’re married (or in a longstanding partnership), you could maximize your partner’s ISA allowance. Imagine a scenario where you have 10,000 to invest and your partner has just 1,000. You would use up your full 7,000 ISA allowance and then transfer the remaining 3,000 to your partner for them to invest in ISAs held in their name. As long as you’re comfortable with the principle of what’s mine is yours’, then this approach makes good economic sense.
Option 5: Utilise children’s tax free options.
You can open a Child Trust Fund (CTF) which is effectively a tax shelter for children. Children born after the 31st of August 2002 can have a CTF. The government will make an initial contribution of 250 0r 500 (depending on the family’s income status), and the parents can then contribute up to 1,200 per year until the child is 18. Not only does it reduce the amount of tax that you’re paying but it will also help to safeguard your child’s financial future. There are 3 different types of CTFs. You can either invest the money in a Savings CTF, or in a Stakeholder CTF, or a Shares CTF. The Savings options just pays regular savings interest, tax-free. The Stakeholder CTF invests the money in a range of shares. The Shares CTF allows you to invest the money in individual shares.
Option 6: If you’ve totally exhausted the other tax-free options, then you might like to consider Premium Bonds.
Premium bonds are a bit of a gamble and I certainly wouldn’t advocate them as your main investment strategy. However, they are another option that you can use on top of the more conventional savings/investment options that I’ve already listed. Premium Bonds work as follows: you buy a set number of bonds (at 1 per bond) and they are then entered into monthly prize draws. You stand a chance of winning a prize if one of your bonds is drawn, and the prize could range from 50 up to 1,000,000. The minimum allowed investment is 100 and the maximum is 30,000. The downside is that you don’t get any interest. The idea is that the amount of prize money paid out over time will make up for the lack of interest. Premium Bonds are offered by NS& I (National Savings & Investments) and their schemes are backed by the Government, and are therefore seen as low risk.
Hopefully, this article has helped to show that there are lots of options for minimising the amount of tax that you will need to pay on your savings and investments. If the above list of options seems a bit daunting, then you may wish to speak to a financial adviser. Bear in mind though that they may be tied to a particular company, in terms of what products they can recommend.