Most of us understand the impact of positive investment returns over the medium term but do we also appreciate the impact on those returns of correct ownership of investments across the family? Appropriate ownership structures built around the optimum use of tax reliefs and allowances can significantly enhance the return after tax. Using the case study below, we illustrate how you can improve the tax efficiency of your investments by using different structures and diversifying ownership.
MRS BROWN’S WEALTH PLAN
Mrs Brown, who runs her own business, has £1m that she would like to invest and has no existing investments. We would suggest the following structure to optimise tax efficiency.
Individual Savings Account (ISA) – ISAs were introduced over 20 years ago and now have many iterations; Cash, Stocks and Shares, Lifetime. In essence though, ISAs are accounts where you do not pay Income Tax or Capital Gains Tax on the underlying investments. Mrs Brown can invest £20,000 into an ISA in this tax year.
Pension - Mrs Brown can contribute up to £40,000 into a personal pension per annum. When Mrs Brown makes the contribution she pays net of 20% basic rate tax. She pays £32,000 and the government adds the additional £8,000 (equal to 20%). Depending on her marginal rate of tax, she may be entitled to further tax relief on the pension contribution. Not only does Mrs Brown receive a tax break on her contribution but the money invested in her pension grows free of Income Tax and Capital Gains Tax. In addition, if Mrs Brown has not maximised her pension contributions for earlier years she may be able to pay further amounts to mop up that unused relief.
Directly owned investment portfolio – Investing using a UK based portfolio is tax efficient because it allows Mrs Brown to use a number of tax allowances available to her:
Personal Savings Allowance of £1,000 for basic rate tax payers or £500 for higher rate tax payers. This means that the first £1,000 or £500 of interest received is tax free. This could be interest from a bank account, so if Mrs Brown has savings elsewhere the Personal Savings Allowance could be used already. However, it can also be applied to interest received from investments.
Dividend Allowance of £2,000 in the current 2019/20 tax year; this means that the first £2,000 of dividends Mrs Brown receives from her investments, outside of her ISA, are tax free.
Capital Gains Tax exemption of £12,000 in the current tax year; when investments are sold and a profit is made the first £12,000 is tax free.
Offshore investment bond – Once Mrs Brown has used her tax allowances it may be suitable for her to invest through an offshore investment bond. This can offer certain tax advantages including no UK Income Tax or Capital Gains Tax on the underlying investments within the bond and the ability to withdraw a fixed amount of money from the bond each year without an immediate tax liability.
HOW MRS BROWN’S FAMILY CAN FURTHER ENHANCE TAX EFFICIENCY
This all sounds sensible but let’s look at how the ownership of investment could improve overall tax efficiency even further:
If Mrs Brown splits her investment with her husband she can double the tax advantages – Mr Brown will be entitled to an ISA allowance, can make pension contributions and is entitled to personal tax allowances.
Mrs Brown can save tax efficiently for her children by using Junior ISAs (for under 18’s) and making pension contributions.
Should Mrs Brown sell her business in the future, and if passing on wealth to the wider family is important, she might consider establishing a Family Investment Company (FIC) through which to invest the business sale proceeds.
A FIC is an investment company whose shareholders are family members. Mrs Brown could define the rights of different classes of shareholder at the outset and control the investment strategy together with her family. Mrs Brown could use a FIC to generate an income for herself whilst also passing wealth on to the next generation.
Mr and Mrs Brown might also consider the tax efficiencies available from investing in specialist schemes such as a Venture Capital Trust. These can provide Income Tax relief on the amount of the investment and tax-free dividends, and capital growth.
As with all wealth planning, the objectives and risk tolerance of the individual and their family are paramount and should inform not only the investment but also the ownership and structuring of that investment.
As we experience regular changes to the tax and regulatory landscape, so too our clients’ circumstances and priorities change, and our regular interactions with them enable us to provide timely and relevant advice on how best to structure their investments. For further information on tax efficient investing or for a review of your overall wealth plan, please contact your usual Brown Shipley Adviser.
The information contained in this article is defined as non-independent research because it has not been prepared in accordance with the legal requirements designed to promote the independence of investment research, including any prohibition on dealing ahead of the dissemination of this information.
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