What are the best UK tax saving investments?

Whether it's to reduce your income tax bill, offset capital gains, or invest for future tax free earnings, there are many different tax saving investment options available to UK taxpayers.

Below we’ll look at everything from the traditional mainstream investment vehicles through to the more alternative options and everything in between.

The different types of tax relief

Income tax relief

EIS, SEIS, and VCTs offer investors a reduction in the income tax bill they owe HMRC. The rate of reduction ranges from 30% for EIS & VCT, up to 50% for SEIS

Pensions also reduce the income tax you pay as your pension contributions, up to a limit are taken from your salary before tax, therefore reducing the income on which you pay tax.

Capital gains tax relief

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

EIS and SEIS all investors to defer paying a capital gains tax on gains that are rolled into one of these schemes.

Tax free dividends

Dividends received from stocks or funds held in an ISA, pension, or VCT are not taxable.

Loss relief

Some of the vehicles allow investors to offset the losses incurred through them against capital gains, or in the case of EIS and SEIS against income as well.

Inheritance tax relief

A number of the vehicles below are eligible for the government's Business Property Relief (BPR) where the shares become 100% inheritance tax exempt after a holding period of just two years, as long as the shares are still held at the time of death.

Comparing the options

Looking at the mainstream tax saving investments

ISAs

An individual savings account (ISA), is a tax-free savings or investment account that allows the investor to maximise the potential of their investment returns by shielding 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 into listed stocks or funds.

Cash ISA: allow 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.

Innovative finance ISA: Allowing investors to invest through Peer-2-Peer (P2P) lending platforms. This ISA is sometimes referred to as the IFISA.

Pension contributions

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).

When it comes to tax relief, you can claim additional tax relief on your Self Assessment tax return for money you put into a private pension of:

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.

Discovering alternative tax saving investments

Alternative tax saving investments are focused on encouraging individuals to invest in new shares of early-stage companies – startups and scaleups – that are either unlisted, or listed on the alternative investment market (AIM). Alternative investments are high risk, but generally offer generous incentives to offset this, together with the potential for significant returns. In addition, alternative investments offer a means of portfolio diversification. The primary alternative investments offering tax relief are as follows.

Venture Capital Trusts (VCT)

Venture Capital Trusts are publicly traded companies created to invest in small businesses. Investors buy shares in the trust itself, rather than the individual companies it invests in, giving them more flexibility when it comes to disposal of shares.

Venture Capital Trusts offer investors:

1. Income tax relief of 30% on annual investment of up to £200,000.
2. Tax free dividends.
3. No capital gains tax on profits from shares.

Shares in VCTs must be held for 5 years or the income tax relief may be repayable to HMRC.

EIS (funds or directly into eligible companies)

The Enterprise Investment Scheme is a system by which investors in small businesses are offered tax incentives. Despite these generous incentives, EIS provides strong support to the UK economy, and has helped to foster a thriving UK startup ecosystem.

With EIS, investors buy shares in the startups themselves. This means shares are harder to dispose of, but also enjoy some degree of isolation from any turbulence in public markets. In general, EIS investments are considered a long term investment, with investors holding shares until companies achieve an exit, at which point returns are paid to shareholders if the exit was profitable.

The Enterprise Investment Scheme offers investors:

1. Income tax relief of 30% on an annual investment of up to £1m (though £2m if the companies are knowledge intensive).
2. No capital gains tax on profits realised on shares held for a minimum of 3 years.
3. Loss relief on investments into companies that go bust.
4. The ability to defer paying capital gains tax on gains that are rolled into an EIS company or fund.
5. Inheritance tax relief on shares held for 2 years.

SEIS (funds or directly into eligible companies)

The Seed Enterprise Investment Scheme (SEIS) is similar to the Enterprise Investment Scheme, only it invests in companies at an earlier stage, meaning the risk is higher. Because of this, the tax relief is more significant, but the investment limit is considerably lower.

the Seed Enterprise Investment Scheme (SEIS) offers investors:

1. Income tax relief of 50% on annual investment of up to £100,000.
2. No capital gains tax on gains realised on shares held for a minimum of 3 years.
3. Loss relief on investments into companies that go bust.
4. Inheritance tax relief on shares held for 2 years.

However, you are not able to defer capital gains through SEIS as you can with EIS.

Which is right for you?

Each of the investment opportunities above has its own trade-offs to be made. The mainstream investments are all generally less risky than those in the alternative category. However, the potential return from the alternatives, should they come off, may far exceed that of the mainstream. Additionally, many of the alternatives have a low correlation to the public markets where the mainstream are often found to invest. This lack of correlation can be a positive when it comes to diversification of your portfolio.

As always, never invest more than you can afford to lose and if you do have a financial advisor it may be wise to speak with them before making an investment.

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