What are tax-efficient investments?
Tax-efficient investments give investors tax relief on investments in qualifying companies or investment vehicles.
Many UK government-approved schemes offer investors tax relief. These reliefs range from capital gains tax (CGT) to loss releif and inheritance tax relief.
As with all investments, there are trade-offs when weighing up the pros and cons of each. Two rules to keep in mind when considering these, or any type of investment:
First, if it sounds too good to be true, it probably is. We’ll only be looking at government-approved schemes in our review.
Second, the more tax relief on offer, the riskier the investment class is likely to be. We’ll get into this later when we talk about the alternative investments that offer tax relief.
Below we’ll take you through the HMRC-approved tax-efficient vehicles and the various reliefs they offer. While you can’t avoid paying tax entirely, you can reduce the amount you pay while diversifying your portfolio and having an impact too.
The benefits of tax-efficient investments
Income tax relief
EIS, SEIS, and VCT investments allow you to reduce the income tax owed to the government by a percentage of the amount invested.
Capital gains tax relief
Some investments, including some ISAs, EIS and SEIS, do not incur taxes on the gains made by those investments when held for a defined period of time.
Capital gains tax deferral
Investors may defer paying capital gains tax on a gain invested through the Enterprise Investment Scheme (EIS).
Inheritance tax relief
Many alternative investments allow investors to take advantage of some form of inheritance tax relief. Investments held for a set number of years fall outside of the estate and are not subject to IHT.
Loss relief
Some tax-efficient investments allow investors to offset their losses against income tax. Typically losses may only be offset against capital gains.
Comparison of tax-efficient investments
The table below compares the different tax-efficient investments on the benefits they offer. We compare ISAs (Individual Savings Accounts), Pension Schemes, EIS (Enterprise Investment Scheme), SEIS (Seed Enterprise Investment Scheme) and VCT (Venture Capital Trust).
Mainstream tax efficient investments
Individual Savings Accounts (ISA)
ISAs provide tax-free savings on investments allowing the investor to maximise returns. ISAs shield the gains from income tax, capital gains tax, and tax on dividends. There are several types of ISA:
Stocks and Shares ISA: Allows investors to invest in listed stocks or funds.
Cash ISA: Earn interest on savings and not pay tax on the earnings.
Junior ISA: Savings parents make for children.
Lifetime ISA: For first-time buyers who must use their savings for the purchase of a home. The government contributes 25% of up to £4000 invested into the ISA each year.
Innovative finance ISA: Allows investors to invest through Peer-to-peer (P2P) lending platforms. This ISA is sometimes referred to as the IFISA.
Pension Schemes
Pensions are either self-managed, through a SIPP (self-invested personal pension), or managed by a fund manager.
Pensions allow for tax relief of 20% on the amount of any income you have paid 40% tax on and 25% on the amount of any income you have paid 45% tax on.
Alternative tax-efficient investments offer more generous tax reliefs than mainstream investments. This comes at the trade-off of an increased level of risk associated with the underlying investments.
Mainstream vehicles invest in large liquid stocks, funds, bonds or held in cash. Alternatives invest in startups, collectables (art, wine, vintage cars) or other illiquid assets. Below we outline a few of the alternatives available.
Investing in startups with EIS and SEIS
Early-stage investing is risky by nature. Startups must find a sustainable competitive edge to compete with incumbents. Shifts in markets and public opinion make it a harder task. Given that, It's unsurprising that nine out of ten startup fail.
Despite the odds, investors continue to back these small, enterprising companies seeking to change the world. For some, it's the thrill, for others, it's the generous tax reliefs. The EIS and SEIS tax reliefs are the envy of startup investors around the world.
The Enterprise Investment Scheme (EIS)
The Enterprise Investment Scheme (EIS) was launched in 1994 to encourage investments in small, high-risk companies in the UK. Each year approximately £2bn flows through the scheme into several startups. The scheme has done its job of encouraging individuals to invest in startups.
Investors receive tax relief on up to £1m per year of EIS investments - £2m if investing in knowledge-intensive companies.
Read more about the Enterprise Investment scheme by downloading our EIS Guide.
- Income tax relief of 30% of your investment. This can be used in the year of investment or carried back one year.
- Capital gains exemption on profits earned on shares held for a minimum of three years.
- Loss relief, should the company you’ve invested in fail, equivalent to your tax bracket multiplied by your at-risk capital (the amount invested less income tax relief received).
- Capital gains deferral on gains realised on the disposal of any asset which is reinvested in an EIS-qualifying company.
- Inheritance tax exemption on shares held for a minimum of two years.
Download our fund brochure.
What is Access EIS?
Read our fund brochure for everything you need to know about Access, which includes a full explanation of our innovative co-investment model to our fees, and instructions on how to invest.
The Seed Enterprise Investment Scheme (SEIS)
The Seed Enterprise Investment Scheme (SEIS) is a tax-efficient investment designed to complement the EIS by helping small, early-stage companies. Like EIS, investments can be made directly into companies, or via an SEIS fund. It does this by offering tax relief to individual investors who purchase new shares in those companies. The main tax reliefs are:
- Income tax relief of 50%.
- Capital gains tax relief on profits realised on shares held for a minimum of three years.
- Loss relief on investments that are realised at a loss.
- The ability to defer capital gains from other investments.
- Inheritance tax relief.
Shares sold before the three-year holding period are subject to clawback of some of the tax reliefs.
Venture Capital Trusts
VCTs are closed-end listed vehicles created in the 1990s. VCTs offer individuals tax relief on investment into early-stage private and AIM-listed businesses. VCT investing offers investors the following tax reliefs:
-Income tax relief of 30%. -No capital gains on profits. -Tax-free dividends.
Shares sold before the five-year holding period are subject to clawback of some of the tax reliefs.
Mainstream Tax Efficient Investments
No mater what rate taxpayer you are there are investment options for you. ISAs and pension contributions are the two most searched-for financial terms during any tax year. ISAs and SIPPs offer tax reliefs on investments considered safer than riskier alternatives. The trade-off of lower risk typically infers lower reward. On the whole, they provide steady growth rather than sizeable returns but for much less risk.
ISAs
An individual savings account (ISA) is one such mainstream tax-efficient investment vehicle. The key to investors is that there is no income or capital gains tax paid on investments made through an ISA. There are several types of ISA:
- Stocks and Shares ISA: Allows investors to invest in listed stocks or funds.
- Cash ISA: allows users to earn interest on their savings and not pay tax on the earnings.
- Junior ISA: Savings parents make for children who can start managing the account at age 16.
- Lifetime ISA: an ISA specifically targeting first-time buyers and must be used for the purchase of a home. Here the government will contribute 25% on up to £4000 invested into the ISA each year.
Pension Contributions
We’ve all heard of pensions, your long-term savings plan that you can hopefully fall back on when you retire. With your pension pot, you can choose to have your pension managed by a fund manager, or you can choose to make more of the decisions yourself through a SIPP (self-invested personal pension).
Investors may claim tax relief on money put into a private pension equating to:
- 20% up to the amount of any income you have paid 40% tax on.
- 25% up to the amount of any income you have paid 45% tax on.
What’s right for you?
As with everything there are pros and cons to all tax efficient investments. Before making an investment you must decide what level of risk you are comfortable with. If you are unable to determine your level of risk please speak to a financial advisor.
Mainstream vehicles serve their purpose. Many investors max out their ISA and SIPP before considering an alternative. With seemingly good reason. Alternatives offer the potential for higher returns at a higher risk of loss. Even with tax reliefs factored in.
Research by Hardman & Co shows how to balance the risk of venture capital in a broader portfolio. This requires upweighting the allocation to bonds and decreasing equities.
However, it's not just the potential returns that lead investors to back startups. Startups create jobs and their research and developments push boundaries. Even in failure startups may have their uses.
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