Tax-efficient savings accounts such as individual savings accounts (Isas) and self-invested personal pensions (SIPPs) are the best option for most savers and investors. Here’s what you need to know.
Isas are tax-free savings accounts.
This means that you are not liable for tax on any income you receive – such as interest or dividends – from the cash or investments in your accounts.
If you own shares or investment funds you will also not pay tax on any capital gains that you make.
With Isas, you have a choice of where to allocate your savings such as:
- Individual company shares
- Investment funds such as managed funds, investment trusts(ITs) or exchange-traded funds (ETFs)
- Corporate bonds
- Government bonds
In a traditional bank or savings account you must declare any interest received above your annual personal income allowance which is £12,570 for the 2023/24 financial year. This is subject to a couple of savings allowances.
Basic rate taxpayers have an annual tax-free interest allowance of £1,000. This reduces to £500 for higher rate taxpayers and to zero for additional rate taxpayers (who earn more than £125,140 per year)
You can also get up to £5,000 of interest tax-free depending on your sources of income. For example, someone earning exactly the personal allowance of £12,570 from wages could receive up to £5,000 of interest from savings and not pay tax. Once their total income went over £17,570, this allowance would start to get used up.
The more income someone earns from wages, the lower the tax-free interest allowance available until the £1,000 personal savings allowance remains. So someone earning more than £17,570 from wages would only have £1,000 of interest income tax-free.
For shares or funds held outside an Isa, there is a £1,000 tax-free dividend allowance.
The government has significantly reduced the capital gains tax (CGT) allowance in recent years. It was £12,300 in 2022/23 and will be £6,000 in 2023/24 before being reduced again to £3,000 in 2024/25. Protecting your investments from CGT has always made sense and even more so going forward.
You can invest up to £20,000 in an Isa each tax year. This can be spread between cash and investments as long as you do not contribute more than £20,000 in total. You can withdraw money from your Isa at any time, but if you have already contributed your maximum annual allowance you cannot add any more until the following tax year.
Isas are counted as part of the value of your estate when you die and would be liable for inheritance tax above an individual allowance of £325,000.
For people wanting to start a pension account, the tax breaks are even better.
You can manage your own pension using a Self-invested Personal Pension (Sipp). This means choosing and managing your own investments as many SharePad and ShareScope users already do.
When you make a contribution to your pension it is usually made from income that has already been taxed.
The government provides tax relief on your pension contributions based on your personal tax band.
If you are a basic rate tax-payer you can get 20 per cent tax relief on your contributions. What this means in practice is that if you contribute £10,000 into a pension you need only pay £8,000 and your pension provider will claim back the £2,000 tax relief for you and add it to your account,
Even non-taxpayers can claim 20 per cent tax relief but only up to a limit of £3,600 per year. This would require a contribution of £2880 before tax relief is claimed for you.
Higher-rate taxpayers can claim an additional 20 per cent or 25 per cent back via their tax return or by writing to the tax authorities with details of their contributions or claiming through an annual self-assessment submission.
So if you pay 40 per cent tax on your earnings an annual pension contribution of £10,000 could cost just £6,000. You pay in £8,000, your pension provider claims back £2,000 for you and you get another £2,000 back in your wages – usually via changes to your tax code.
All income earned within a SIPP and all capital gains are tax-free. There is now no limit on the value that can be accumulated in a pension fund.
You can contribute 100 per cent of your income up to a maximum of £60,000 per year into a Sipp. This allowance includes money contributed into personal and company pension schemes and any money paid by your employer.
It is possible to pay in more than £60,000 in a tax year if you did not use all your allowance for the previous three tax years.
You can access your Sipp from the age of 55 (57 from 2028).
Since April 2015, how you take income from a Sipp has become a lot more flexible.
Before then, when you retired, 25 per cent of your fund at retirement could be taken as a tax-free lump sum. With the remaining 75 per cent most people had to buy an income for life from an insurance company – known as an annuity.
During the last decade when interest rates were low, annuities came in for a lot of criticism because they seemed to offer poor value for money. That view might be changing as interest rates have increased recently.
Instead of an annuity, you can withdraw money from your pension fund instead.
You can still take up to 25 per cent tax-free but this is now capped at a maximum of £268,250. However, instead of being forced to buy an annuity with what’s left over, you can choose to leave this money invested and draw down as much money that you need to live on each year.
Using SharePad, you can invest and manage this money yourself.
Instead of taking a 25 per cent lump sum – or even your whole pension pot – in one go, you can opt for something known as phased withdrawals.
25 per cent of your withdrawal will be tax-free with the rest subject to income tax at your marginal rate taking into account any tax-free allowances that you might have.
The value of your Sipp is not subject to inheritance tax if you die before the age of 75. If you die after 75, then it will be taken into account when valuing your estate for inheritance tax purposes.
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This information is intended as general advice. Your individual tax circumstances may be different. If you are unsure, talk to your accountant, your tax office, or one of the SIPP providers.
This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.