Why You Should Think About Tax Before Investing
It’s easy to forget about tax when looking at the returns on your investments. For ordinary savers interest rates have been so low in recent years that the amount of tax coming off current or investment accounts may appear negligible. However if you have a range of investments or are planning to set up new ones it’s important to know the tax implications for each product otherwise your investment may not be as good as you think.
Investment income liable for tax doesn’t just come from people’s pay packets and personal savings. Tax is payable from rental income, dividends from shares and capital gains tax from the sale of either property or shares.
Check your allowances
If you live in the UK, the personal allowance of £9,440 for people of working age still applies but any income generated by your investments will be added to your main income so that once you go over the threshold you will pay tax. If your investments take you into higher tax brackets, you will be taxed at that higher rate. With the 40% rate becoming applicable for any income over £32,011, it is easy to slip into a higher tax bracket even if you earn a modest salary.
Tax efficient investing is therefore important to ensure the yields are not diminished. Cash and stocks and shares ISAs are one way to ensure that some of your wealth is protected. Investors enjoy an allowance of £11,520 and any revenue earned from this is protected from tax. Another method of tax efficient investing is to take out a pension. Contributions are tax-free up to a certain point. On retirement, investors can take out a lump sum which is tax-free, whereas drawing a pension at regular intervals will be tax liable. Children’s savings plans and NS&I, the government backed savings institution also offer tax breaks on investments.
Most other investments will incur a degree of tax. The rates vary depending on the type of investment. For example tax on dividends is 10% for a basic rate tax payer but 42.5% for those in the highest tax band. In the case of capital gains tax, a tax break of £10,600 is offered. However there are other reliefs and exemptions which could reduce or even wipe out a CGT bill.
As with any financial planning tax needs to be considered before any investments are made. Keep a careful eye on Budget changes in taxation as the Chancellor of the Exchequer will usually tweak both the rates and the breaks if investors appear to be doing too well.