There are many kinds of tax wrappers available that add value to savings and investments whilst shielding them from taxation. Thomas Adcock, Tax Partner at London accountants, tax and business advisers CBW, explains the benefits of pensions, ISAs and offshore funds as well as diversifying tax wrappers
This article was written for and first published in Property Investor News.
No-one likes tax, especially when it reduces the growth of your investments. Consider that for every £1 of growth that your savings enjoy, 40% is collected by HMRC, and that same £1 that could have been reinvested is reduced to just 60p. If you then apply the same going forward, the outcome just gets worse.
Helpfully, there are a number of tax-free products or wrappers that are available, which allow your savings to grow tax free but are dependent on a number of conditions. The difficulty for investors is in a choosing the right one and adding to the complexity is that frequently it is a case of choosing a mixture of products. Clearly, this area is complicated and investors should always seek professional advice from both a tax adviser and an IFA.
Pensions are, of course, the most obvious wrapper. Not only do funds invested within them grow tax free, but there is also tax relief on the amounts that get invested. Investors also get to withdraw a tax-free amount which is broadly equal to 25% of the fund. Furthermore, they are generally outside the scope of inheritance tax (IHT), which is critical and frequently overlooked.
However, pensions can have their downsides. In recent years, the amount that can be invested annually has been restricted steadily and is now between £10,000 and £40,000 a year, depending on income. There are also a number of notable exclusions to the permitted investment; residential property being the most obvious one.
Moreover, if your funds were to grow beyond £1m, which is known as the lifetime allowance), HMRC imposes excess tax charges on that growth when it is withdrawn. There is also the fundamental issue that funds cannot be withdrawn until investors are aged 55 at the earliest without incurring penal tax charges (and that is if you can find a trustee that will do it!). So, what are the alternative routes to tax-free investing?
First, there are ISAs. Tax-free savings accounts have been around for some time in various guises. However, as the amount that can be saved within them annually has grown so has their attraction to investors. Unlike pensions, you do not get tax relief on the way in, but you are not taxed on the way out either. Furthermore, whilst there is an annual limit to what can be invested, there is no equivalent of a lifetime allowance and therefore your investments can grow without suffering potential tax charges in the event that strategies prove too successful.
However, they suffer similar restrictions on investment permissions as pensions. This means that they cannot invest in residential property, but their flexibility is a real draw for investors.
The Chancellor is set to announce the rules behind his predecessor’s Lifetime ISA shortly, which works in a similar way to a pension as it grants tax uplifts on funds deposited, but restricts the use of those funds going forward, for example, buying your first home and retirement. Only time will tell whether this will attract further users of these popular wrappers.
Offshore pension funds
The main problems with pensions and ISAs are the limits on investments and the list of permitted investments. This is where Qualifying Non-UK Pension Schemes (QNUPS) come in. They are broadly offshore pension funds, but don’t let the word “offshore” put you off. The world is changing and you should not be immediately discouraged as not everything offshore is tax avoidance.
The UK government keeps tight control over who is permitted to operate QNUPS – there is a list – but there is no requirement for the trustees to report to the UK government. Furthermore, they must operate as pensions, for example, they cannot pay benefits to beneficiaries until retirement (typically 55). From a tax point of view, there is no tax relief on the way in and no tax uplift within the fund. And, perhaps worse than that, payments to beneficiaries are chargeable to UK tax (over and above a tax-free amount similar to regular pensions). So why use them? It’s simple. In addition to being a tax-free wrapper, they have no lifetime allowance, and here’s the kicker: they can invest in residential property.
I am not a financial advisor, but I think it’s safe to say that it is sensible to hold a diverse portfolio, especially in interesting times. Therefore, given the multitude of changes to pensions over the last few years, perhaps it is sensible to look at diversifying the wrappers through which you make your investments, too.
Thomas Adcock is a Tax Partner at CBW, who began his career as a corporate tax inspector for HMRC. He has extensive experience in the tax affairs of small and medium-sized owner-managed businesses as well as multinational corporations. Thomas also advises individuals on their tax enquiries. For more guidance on offshore structures, he can be contacted on 0207 309 3856 or alternatively at firstname.lastname@example.org.