With just a little thought and planning, you can save yourself around 10% a year in tax.
This can be achieved simply by using one of the most common investment vehicles out there – an ISA. Most people think of ISAs as a cash product, when in fact they are a much better home for investments. ISAs are commonly advertised as tax-free bank accounts but, in reality, this isn’t actually much of a benefit!
How can this be? Well, for basic rate taxpayers, the first £1000 of interest on your cash savings is already tax-free. Similarly, for higher rate taxpayers the first £500 of interest won’t be taxed. You’d have to save a fairly significant amount to exceed these levels of interest.
So, what is the key benefit of an ISA? They are completely free of income tax and capital gains tax.
The tax-free environment makes Stocks and Shares ISAs an important vehicle when growing your wealth, and you can invest in anything from funds to direct companies. Whilst you may well have paid income tax on earnings you put into your ISA, there will be no further tax to pay when you come to access your money.
This is the big difference to withdrawals from pensions, which are always taxed at your marginal rate. As such, it’s vital to have a balance of both pensions and ISAs. It ensures wealthier individuals, in particular, can access the income levels they require whilst keeping tax to a minimum.
One of the other benefits (or drawbacks, depending on how you look at it), is that you can access the money whenever you need it, compared with a pension, which is locked-up until you reach age 55. Having both a long-term pension and an easily accessed ISA in your armoury is a great way to stay prepared in case life throws something unexpected at you.
To illustrate the tax benefits of an ISA-pension savings split, if in retirement someone received £50,000 a year, wholly from their pension, they would pay £7,500 a year in tax. However, if that income was split 50/50 between a pension and an ISA, they’d only pay £2,500 a year in tax. You might notice that’s a 10% annual difference from just basic tax planning. Something you’d struggle to find through investment performance alone.
So, if you can, try to make the most of the wrappers available to you, balancing tax breaks now with tax breaks in the future to create your 10% income boost.