The Basics
It makes sense to invest so your money is working hardest for you. By choosing tax-free investments, you won’t have to share your returns with the taxman, so you will in effect be getting an extra return of 20% if you are a basic rate taxpayer, or 40% if you pay higher rate tax. In the current low interest environment, tax free investing is particularly important as it can help to maintain the real value of your savings. Tax-free investments range from the secure to the risky. For many products there is an annual investment allowance for each tax year, and if you do not use your allowance you will lose it.
But don’t put all your eggs in one basket. Before turning to tax free investments, you should make sure you are maximising your personal tax allowances. Couples can often save money by splitting their savings more tax efficiently. For example, if one partner pays a lower rate of tax than the other, or does not have an income, putting savings into that partner’s name can reduce a couple's overall tax bill. This can be especially useful for couples aged 65 or over as they each receive an extra age allowance. Both can have an income of up to £9,030 free of tax, rising to £9,180 at age 75 (for the 2008-2009 tax year).
It is also useful to remember the annual Capital Gains Tax (CGT) allowance (currently £9,600 for the 2008-2009 tax year) which means if you put your money into investments that produce capital growth instead of income you can take these gains tax free.
Build up your tax free cash savings first and then consider longer term options such as stocks and shares ISAs. Don’t take more risks than you are comfortable with for the sake of saving tax.
Tax Free Schemes
National Savings & Investment Certificates - National Savings Certificates are the most secure tax-free products available, as they are backed by the Government. There are two types available to investors, both pay interest tax- free.
Individual Savings Accounts (ISAs) - Up to £7,200 can be invested in ISAs each tax year. The money can be divided between stocks and shares and cash ISAs, with up to £3,600 going into a cash ISA and up to £4,200 going into a stocks and shares ISA, or alternatively it can all be invested into one stocks and shares ISA.
PEPs - PEPs were tax free investment plans that were designed for investing in stocks and shares between 1987 and 1999. All PEPs were to converted to ISAs in April 2008. For further information please visit our product guide on ISAs and PEPs.
Tax Free Friendly Society Plans - Friendly societies enjoy special concessions that allow them to offer savings plans. They are a form of endowment policy and run for a minimum term of ten years. However, the maximum investment is £25 a month, and this low limit means the charges on the plans are often disproportionately high – offsetting their tax advantages.
Venture Capital Trusts (VCTs) - Investment funds that provide capital for new or expanding businesses currently listed on the stock exchange or the Alternative Investment Market (AIM). But it is important not to be blinded by the tax concessions on these schemes. Smaller, newer companies have a higher likelihood of going bust than larger, established ones.
Premium Bonds - Premium bond prizes, ranging from £50 to £1 million, are tax-free. Individuals can hold between £100 and £30,000 in bonds and there is no minimum age limit. Although you can get your stake back at any time, premium bonds are not regarded as true investments. Since no interest is added, unless you receive regular prizes, the value of your money will be gradually eroded by inflation.
