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Tax efficiency

Tax efficiency is when a person or a business lawfully pays the least in tax that they need to. It is not the same as tax evasion. 

It tends to be a type of financial arrangement that allows you to lawfully pay either no tax or less than usual. Without these types of financial arrangements, many higher rate taxpayers in the UK run the risk of paying more taxes than they need to on their investments.

Understanding tax efficiency

Any earnings you make from investments, such as stocks, shares and property, are taxable in the eyes of HMRC. You’ll be required to pay Capital Gains Tax if your profit from these assets is over the allowance threshold (For the 2021/22 tax year, this allowance is £12,300).

You can structure these investments to be tax-efficient, meaning that you won’t have to pay as much tax as you would have done otherwise. There are all sorts of ways to achieve tax efficiency when investing. 

Why does it matter? 

Being tax efficient is particularly important for people who fall under the higher rate income tax band. Why? If you have a higher tax liability, the value of any earnings you make from your investments can dwindle over time.

How can you invest tax-efficiently?

There are a number of ways to be more tax efficient with your investments. The more annual allowances you use, the more money you’ll be able to save and invest for your future.

Examples include:

  • Individual Savings Accounts (ISAs): This is one of the most straightforward ways to invest tax-efficiently in the UK, especially with a Stocks & Shares ISA
  • Pensions: Capital gains and investment income are tax-free within pension accounts, and when you contribute into a pension, the Government will also provide you with tax relief
  • Venture Capital Trusts (VCT): These are specialised funds that invest in companies and start-ups that are just starting out in business. Because of their importance in supporting the economy, VCTs offer quite a few tax benefits to anyone who decides to invest

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