Choosing the right tax wrapper - as important as choosing good investments


The chances are you’re paying more tax today than you were just a few years ago. The latest statistics from HMRC show that it pulled in an extra £11bn in income tax in 2018/19 alone. Unless you’re an oligarch that won’t all have come from your pocket, but it should at least focus your mind on the importance of tax when investing.

Investment platform AJ Bell crunched the numbers and found that UK citizens are paying almost 30% more in income tax than they did 10 years ago. Mostly this is through ‘stealth’ tax rises - the ones you barely notice. Tom Selby, senior analyst at the group said:

“A number of factors have contributed to rising income tax bills in recent years, including the slashing of the dividend allowance from £5,000 to £2,000 and tax bands either being frozen or rising at a slower rate than wages. Both of these have resulted in more people being dragged into the higher and additional-rate tax brackets over the last decade or so.”


Tax can be pernicious

If you squirrel money away in savings and investments (and let’s not forget, this is money on which you’ve already paid tax) and that money grows in value – either because you’ve invested it in something clever, or you’ve received dividends on it (also quite clever) - you are liable to pay tax on that growth or income.

This can be quite chunky. If you make £10,000 in dividends and are a 40% taxpayer, you will lose around £2,600 in tax. As such, it can be just as important to get the tax right as to get the investment right. There may be a marginal difference of 5% or 10% between the performance of one collective fund over another, but an investor could be losing 40% on the wrong tax decision.

Also, you may find that allowances magically fade away as you earn more money. As a basic rate taxpayer you get a personal savings allowance of £1,000 a year, but that dips to £500 by the time you move into the higher tax bracket, and disappears altogether if you’re paying tax at 45%.

Everyone gets a tax-free Dividend Allowance of £2,000 a year, but the tax you pay after this amount climbs quite sharply. Basic rate taxpayers are only paying 7.5%, but additional rate taxpayers are paying 38.1%. Ouch!


It is worth considering some basic tax rules when investing

  • Where possible, use a tax wrapper such as a pension or ISA. Both allow your investments to grow free of capital gains. Any income paid out is also free from tax. The allowances are generous - £20,000 per year for an ISA and up to £40,000 for a pension (depending on your salary).

  • Keep an eye on capital gains. Capital gains tax (CGT) is as low as it’s been for some time, but it will still take around one third of your investment. Particularly perilous are those assets that you’ve held for a long time – they can show significant gains and HMRC won’t give you any credit for how long you‘ve held them. You have a £12,000 allowance each year, so make the most of it.

  • Increase pension contributions when you move to a higher income tax band. Selby from AJ Bell suggests, “this is a sensible and legitimate way to reduce the amount of income tax you pay.” The pension contributions put you back down below the higher income band and reduces your tax bill.

Tax is, obviously, very boring. However, it can be expensive to neglect it. While complex tax avoidance schemes can be dismissed, it is always worth taking advantage of government-backed, well-established options such as pensions and ISAs. Without them, the tax collectors will continue doing their best to wring you dry.

What's next?

Join the thousands of people who get our weekly musings on money, great products, top tips and a dollop of opinion.

Sign up to Holly's Blog

Want to know more?

tax free childcare.jpg

Tax-Free Childcare: get up to £2,000 a year towards childminders and clubs

If you're a working parent and your child is 11 or under, you might qualify for Tax-Free Childcare. Read on to see if you could save up to £2,000 a year on carers, clubs and more.

Tax-Free Childcare: get up to £2,000 a year towards childminders and clubs

calc fees article cover.jpg

Introducing our independent Investment Fees Calculator

Do you know what you’re actually paying in investment fees? It’s one of the biggest questions in the game, what with ambiguous fee structures, jargon-packed documents, and no clear way to compare providers. Until now! Introducing our Investment Fees Calculator.

Introducing our independent Investment Fees Calculator

Learn the Tribal Way

What have other people been doing? Learn from their experiences.

You may think the stock market is risky. But you know how important it is to save and are fed up with getting pennies in interest every year. Overcome your suspicion and see what investing is really like.

Suspicious Savers

Related Questions

Got a Question?

Sign up for Holly's blog

Stay up to date

Our free weekly blog with Holly's
no-nonsense opinions, tips & food for thought.
If you change your mind, you can unsubscribe at any time. We'll never share your details and you can unsubscribe any time.