Investing 101: What you need to know about tax efficiency and your investment options

Investing may provide a useful way to grow your wealth, but getting started can be overwhelming. There are some important decisions to make when investing that could affect the outcomes and the tax you’re liable for, and we’re here to offer support.

Last month, you read about investment risk and what to consider when creating a risk profile. Now, read on to discover what your options are if you’re ready to start investing.

Shares v funds: What’s the difference?

Investing is filled with terms that can seem confusing. When you’ve looked at investing, you may have come across options like investing in shares or through a fund.

You may want to consider both options and understanding the differences is important.

Shares

When you purchase a share, you’re investing in a single company. When you hold a share, you essentially own a very small portion of the business. You can then sell the share at a later date and, hopefully, make a profit.

The value of shares is affected by demand. A whole range of factors can affect demand, from company performance and long-term plans to global economic conditions.

If you purchase shares, you’re in control and can decide which companies to invest in and when to sell them.

It’s normal for the value of shares to fluctuate, even daily. It can be tempting to try and time the market by buying when the price of a share is low and selling when it’s high. However, consistently timing the market is impossible. For most investors, buying shares to hold them for the long term often makes sense.

Funds

A fund pools together your money with that of other investors. This money is then used to purchase shares in a range of companies.

A fund is managed on behalf of investors. So, you wouldn’t make decisions about which companies to invest in or when to buy or sell shares.

There are lots of funds to choose from, so you can select an option that suits your risk profile and goals.

Funds can be a useful way to ensure your investments are diversified. As your money is spread across many companies, it can help create balance. When one company performs poorly, the success of another could balance this out. So, the value of your investment in a fund may be less volatile than individual shares.

However, the value of your investment will still rise and fall, and investing with a long-term plan is often advisable.

2 tax-efficient ways to invest and reduce your potential tax bill

When you sell certain assets and make a profit, you could be liable for Capital Gains Tax (CGT). This includes investments that aren’t held in a tax-efficient wrapper.

For the 2023/24 tax year, individuals can make £6,000 of gains before CGT is due – this is known as the “annual exempt amount”. If profits from the sale of all liable assets exceed this threshold, you could face a CGT bill. In 2024/25, the annual exempt amount will fall to £3,000.

The rate of CGT depends on your other income, but when selling investments, it can be as high as 20%. So, CGT may significantly affect your profits.

The good news is that there are tax-efficient ways to invest that could reduce your bill, including these two:

1. Invest through a Stocks and Shares ISA

ISAs provide a tax-efficient way to save and invest. For the 2023/24 tax year, you can add up to £20,000 to ISAs. The returns made on investments held in a Stocks and Shares ISA are not liable for CGT.

There are many ISAs to choose from. They can hold shares or you can invest in a fund through one. Usually, you can access your investments that are held in an ISA when you choose.

2. Use your pension to invest for the long term

If you’re investing with your long-term wealth in mind, you may want to consider pensions. Pensions are tax-efficient for two reasons.

• First, you could claim tax relief on the contributions you make. This provides a boost to your contributions, which may grow further too, as tax relief would be invested alongside other deposits.
• Second, your investment returns are not liable for CGT when held in a pension. Instead, you could pay Income Tax when you start to access your pension once you reach retirement age.

In 2023/24, you can usually add up to £60,000 (up to 100% of your annual earnings) into a pension while retaining tax relief – this is known as your “Annual Allowance”.

If you are a high earner or have taken an income from your pension already, your Annual Allowance may be lower. Please contact us if you’re not sure how much you can tax-efficiently save into a pension.

Before you start investing in a pension, one key thing to consider is when you’ll want to access the money. Usually, you cannot make withdrawals from your pension until you are 55, rising to 57 in 2028. So, your goals and other assets should play a role in deciding if investing more into a pension is right for you.

Contact us if you have questions about your investment portfolio

We can work with you to create an investment portfolio that suits your risk profile and goals. We’re also on hand to answer any questions you may have, from deciphering financial jargon to explaining tax-efficient options. Please contact us to arrange a meeting to talk about your investments.

Once you’ve set up an investment portfolio, how often should you review the performance? Why is ongoing advice useful? Read our blog next month to learn about managing investments on an ongoing basis.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.