High Earner Tax Reduction & Investment Strategies

Posted on July 28, 2020

With careful planning there are many legitimate ways to channel more of your earnings into investments and lower your Income Tax bill at the same time.

Recent governments have introduced a number of initiatives to minimise tax paid on certain savings and investments vehicles. Here are a number of ways those with high incomes can invest tax-efficiently.

ISAs (Individual Savings Accounts)

Your first thought should be for an Individual Savings Account or ISA, which allows £20,000 to be invested tax free each year. A Stocks & Shares ISA typically doesn’t lock your money away and you can withdraw any proceeds free from Capital Gains Tax and without incurring any other tax that would normally be due on dividend income and/or interest.

Don’t forget the children (or grandchildren)

If you want to provide for young family members then a Junior ISA allows up to £9,000 (for the tax year 2020/21) to be saved for each and every child. On the child’s 16th birthday the annual allowance rises to £20,000. On their 18th birthday no more payments can be made on their behalf and they become the official and legal owner of the account.

ISAs for other family members

Gifts to family members are not subject to tax so long as you are still living seven years from the date of the gift. The official term for such a gift is a Potentially Exempt Transfer, but if you should you die before the seven year cutoff point then the gift is considered a Chargeable Transfer and Inheritance Tax will be due on it.

Provided you remain hale and hearty you could make payments into ISA accounts (perhaps a Lifetime ISA to help family members become home owners). And, whilst the gifted sum remains potentially liable for IHT, any income from or growth in the value of assets held via the ISA is protected from the taxman.

Pensions

Successive governments have been keen to encourage people to make provision for their retirement, and there are various tax breaks associated with investing via a pension ‘wrapper’.

Firstly, there is no Capital Gains Tax on a rise in the cash value of your investments.

Secondly, there is no Income Tax on pension fund earnings (but do note this is pension fund income, not pension fund withdrawals).

Thirdly, tax relief is available on contributions to your pension fund at the highest rate of Income Tax payable, which is currently 45%.

Do be aware that there are limits placed on pension investments.

Tax relief on contributions is limited by an individual’s ‘Annual Allowance’. The standards allowance for is £40,000 or 100% of your ‘net relevant earnings’ (whichever is lower). If you earn more than £200,000 per year then this annual allowance is reduced (or ‘tapered’), although there are ‘carry forward’ rules that allow you to utilise unused allowance from the last three years against current year income. This has become a complicated area of financial planning, and needs careful consideration.

Furthermore, do be aware that if you are either a high earner or end up holding particularly successful investments via your pension, then there is a ‘Lifetime Allowance’ that sets a ceiling on the capital value of the pension fund, after which a special pension tax applies to the surplus.

Life insurance backed bonds (death bonds)

These can be offered by major insurers (or by companies who buy up life insurance policies from them for an up front lump sum and then collect the ongoing premium payments from the policy holders). Either way, the guaranteed income afforded by a pool of life insurance premium payments allows for bonds backed by that financial security to be offered to the market. So long as the ultimate investments are sound, then the bond issuers can pay the bond holders from that income, with the policy holders’ money only used to tempt prospective bond buyers with the promise of a higher level of financial security.

Currently £3,600 can be invested each year. Annual withdrawals of up to 5% of the original bond purchase price can then be made tax-free, with income tax becoming due on withdrawals exceeding 100% of that original price. It is possible to carry over this 5% allowance from one year to the next, even up to 100% after twenty years.

Capital Gains Tax (currently 20% for 2020/21) is due on increases in the value of bonds issued by UK-based businesses, although there is a (non-reclaimable) tax credit equivalent to the rate of Corporation Tax (18% for 2020/21), reflecting the tax already paid by the bond issuer.

Offshore death bonds are also available. Whilst the bond issuers are not liable for UK Income Tax or Capital Gains Tax, a UK-domiciled bond holder will have gains taxed as income (so 40% / 45% for high earners in 2020/21) if they cannot bring either their personal allowance or personal savings allowance to bear.

Employee Share Schemes

Some businesses make shares in the company available to employees at a discount, and these schemes can involve tax breaks on the investment. However the guidelines in this area are far from simple and there are a great deal of variables that will affect the tax that might be liable. All of the following currently offer some form relief on Income Tax, Capital Gains Tax, or National Insurance.

Share Incentive Plan (SIP)

So long as shares are kept in the plan for five years, they are not subject to Income Tax or NI, nor is Capital Gains due.

Save As You Earn (SAYE)

You can pay into a savings scheme monthly for either three or five years and then use that money to buy shares, with no Income Tax or NI due on the difference between their market value and your actual purchase price. Plus, so long as you put your purchases into either your ISA (within 90 days) or your pension (immediately), then no Capital Gains Tax will be due.

Company Share Option Plans

Spending up to £30,000 on shares at your employee discount will not leave you open to Income Tax or NI on any difference between the price you pay and the normal cost of the shares.

Employee Shareholder

If you buy shares to the value of at least £2,000 then you can qualify as an employee shareholder. Since 17th March 2016, although both Income Tax and NI are due on your purchase(s), Capital Gains Tax will only kick once your shares are worth £100,000 or more.

Venture Capital

This type of investment should not be your first port of call. However, if you have made good use of all the other avenues that are open to you and have an appetite for riskier investments then you could consider venture capital. The UK government has set up three different schemes which all offer generous tax concessions for those who are prepared to invest on young businesses that are early on in their life cycle.

Enterprise Investment Scheme (EIS)

Created to incentivise investment in medium-sized companies that are not listed on the stock exchange (and also have no plans to be listed) the EIS benefits for investors include:

  • Income Tax relief of 30% of the amount you invest (all the way up to £2 million);
  • no Capital Gains Tax (provided you hold your shares for at least three years);
  • deferral of Capital Gains tax due on other assets (provided you reinvest your profits into EIS shares;
  • Inheritance Tax relief (provided you hold your shares for two years).

Seed Enterprise Investment Scheme (SEIS)

A scaled-down version of the EIS for smaller start-ups that need to raise up to £150,000 from investors, who will get all the perks mentioned above and more (Income Tax relief here is 50% of the amount invested).

The marketplace for EIS and SEIS investments can be accessed either directly as an individual via specialist brokerages, or indirectly via a form of collective investment scheme called a Venture Capital Trust.

Venture Capital Trusts (VCTs)

VCTs themselves are listed on the stock exchange, and offer some of the tax breaks of direct ownership, although the exact benefits depend on whether you purchase new or existing (i.e. second-hand) shares. For previously owned shares you can expect tax-free dividends and capital gains; for newly issued shares you can add Income Tax relief of 30% on purchases of up to £200,000, provided the shares are kept for at least five years.

How to proceed

It is important to realise that none of these investment options operate in a vacuum: it is your entire ‘financial footprint’ that determines your liability for Income Tax.

That which seems like a great idea by itself might turn out to be an ill-considered move when your other taxable activities for the year are tallied.

It is possible to make effective use of your maximum annual contributions and withdrawals with an eye to both Income Tax and Capital Gains Tax, but this requires careful planning, and we would always advise consulting an experienced and regulated professional advisor who can weigh all the information and come up with a financial plan tailored to your specific needs.

INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.

THE TAX BENEFITS RELATING TO ISAS AND INVESTMENTS MAY NOT BE MAINTAINED. TAX RULES ARE COMPLICATED, SO YOU SHOULD ALWAYS OBTAIN PROFESSIONAL ADVICE.

THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED. PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.

A PENSION IS A LONG-TERM INVESTMENT. PENSIONS ARE NOT NORMALLY ACCESSIBLE UNTIL AGE 55. YOUR PENSION INCOME COULD ALSO BE AFFECTED BY INTEREST RATES AT THE TIME YOU TAKE YOUR BENEFITS. THE TAX IMPLICATIONS OF PENSION WITHDRAWALS WILL BE BASED ON YOUR INDIVIDUAL CIRCUMSTANCES, TAX LEGISLATION AND REGULATION, WHICH ARE SUBJECT TO CHANGE IN THE FUTURE.

No guarantee can be given that the information provided is accurate in the present or the future. It is not intended to constitute either a statement of applicable law or financial advice, and responsibility cannot be accepted for any subsequent loss following activity or inactivity by any individual or organisation. Indeed, such information should NOT be acted upon without first receiving appropriate and specific professional advice.