In the previous post, we looked at ways to diversify your savings. Here, we'll look at another option.
Consider Advanced Investment Wrappers
What other forms of diversification might you consider? Different tax advantages is an obvious one. We touched briefly on EISs and VCTs in an earlier post, which are special types of tax-wrapper with potentially massive tax advantages.
Enterprise Investment Schemes (EIS) have the facility to roll over capital gains tax (CGT) and defer the tax due. Let’s say you sell a property and make a big gain, on which you’d have CGT to pay. You can roll over the gain into an EIS and you won’t have to pay the CGT when it is due.
You also get 30% income tax relief, which is not insignificant. As long as you keep the EIS for three years after investment, you can then sell down enough shares each year to make a gain within your CGT allowance and potentially pay no tax at all. Any gains you make on the actual EIS investment are CGT-free.
If you make a loss on an EIS, you can offset that against income tax. There’s no inheritance tax payable on EIS assets after you’ve held them for two years. The only downside – dividends received are taxable. But as EISs generally invest in small companies, they’re unlikely to issue a dividend anyway.
Here’s an example of how I have used an EIS in the recent past. I have a client couple who married late. He had a property which he had lived in as a bachelor for a while and rented out for a long time. When they decided to sell it, they figured it was a good idea to put the property into joint names, thereby getting the benefit of two CGT annual allowances.
It seemed to make sense, but because she had never lived in the property, she didn’t get any of the residence relief that he did, so on her half of the property proceeds, it was all deemed as gain. Just like that, they conjured a £75,000 CGT bill out of nothing. Not good, and a classic example of a little bit of knowledge getting people into a worse pickle than had they a) taken advice or b) left things as they were.
We invested her gain into an EIS so she didn’t have to pay the CGT bill when it fell due. She also had recently retired as a headteacher and started drawing her teacher’s pension, but had both earnings from her last term working and her pension in the year they put the house in joint names.
She also had another small pension pot that we invested for her in that same year. Ordinarily that would have caused her an income tax bill, but as she got income tax relief from the EIS, we were able to wipe out her income tax bill for the year.
She will end up paying no CGT and she paid no income tax in the year we advised her. We saved her somewhere in the region of £100,000 in tax – a very tangible example of a good financial planner adding value way in excess of the fees charged. For you, adding in an EIS may diversify your investment approach and your tax planning, so it is worth considering.
A Venture Capital Trust (VCT) is another specialist tax wrapper that offers 30% income tax relief. There are no CGT rollover or IHT benefits, but any gains you make are CGT-free. You have to keep your VCT investment for five years to keep the income tax relief, otherwise you’ll have to pay it back. BUT incredibly, you can roll money over from one ‘maturing’ VCT (one you’ve held for more than five years) into another one and get income tax relief again on the same money.
If you have income tax ‘issues’ then these are useful vehicles to consider, but always remember that these are much higher risk than typical investments as they hold shares in smaller companies which have a correspondingly higher risk of going bust, losing your money altogether. Never let the tax tail wag the investment dog. Be comfortable with the investment first – the tax benefits are gravy.
OK, on to the final post!
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