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Tax-efficient investing through an Investment Trust

Karl 3rd Apr 2023 No Comments

Reading Time: 5 minutes

This investing post is sponsored by Alliance Trust.

In life, there are only two things that are certain: death and taxes. While we can’t avoid the first, there are ways for investors to shield their assets from taxes.

In this article, we’re going to explain how investors can protect their wealth from tax. Plus, we’ll take a look at tax-efficient investing through an Investment Trust. Keep on reading for all of the details, or click on a link to head straight to a section…

What is tax-efficient investing?

Tax-efficient investing refers to organising your investments in a manner that allows you to reduce the amount of tax you pay on your assets.

In the UK there are two taxes that typically apply to investments: Capital Gains Tax and Dividends Tax.

These taxes have annual tax-free allowances so some investors can avoid paying them. However, both allowances have been cut for the 2023/24 tax year. Here’s what you need to know…

Capital gains & Dividends tax explained

Sell an investment or asset that isn’t held in an ISA or pension, and you may have to pay Capital Gains Tax. Similarly, if you invest in a company that pays dividends, you may have to share your spoils with the taxman.

Let’s explore these taxes in more detail…

Capital Gains tax

Capital Gains Tax (CGT) applies to most types of investments, such as stocks, bonds, mutual funds, and even cryptocurrency. CGT may also be payable if you sell a property that isn’t your main home.

Importantly, however, you only have to pay CGT if the gain you make from selling an asset is greater than the ‘Annual Exemption Allowance’. For the current 2023/24 tax year, the allowance is £6,000.

For gains exceeding the annual allowance, the CGT you must pay depends on your income. For higher or additional-rate taxpayers, you pay 28% on residential property gains, and 20% on other assets.

If you’re a basic-rate taxpayer, then you only have to pay 10% tax on your gains (18% on residential property). However, you will have to pay the higher rates if your gains move you into the higher-rate tax bracket.

Dividends tax

A dividend is a payment a business makes to eligible shareholders as a reward for investing in the company. Dividends tax is the tax that applies to these payments.

Similar to Capital Gains Tax, every investor gets an annual tax-free dividends allowance. If you earn less than this allowance in a given tax year, you won’t have to pay any tax on dividends.

For the current 2023/24 tax year, the dividends allowance is £1,000.

If your dividend payments are more than this allowance, then the amount of tax you pay depends on your total income. If you’re a basic-rate taxpayer, you’ll pay 8.75% dividends tax. Higher-rate taxpayers, meanwhile, pay 33.75%. Additional-rate taxpayers pay 39.35%.

Similar to CGT allowance rules, if the dividends you receive pushes you into a higher tax threshold, you’ll pay a higher rate of tax, but only on the amount that takes you above the lower rate. This is why some investors may pay dividends tax at more than one rate.

Changes for the 2023/24 tax year

On Thursday 6 April 2023, a new tax year began.

Usually a new tax year is a cause for investors to celebrate. That’s because a new tax year also brings a host of new tax-free allowances. However, for the 2023/24 tax year, it was a little different, as both the Capital Gains AND Dividend Tax allowances were cut.

For 2023/24 the dividends allowance has reduced from £2,000 to £1,000 and it will be reduced again to £500 for 2024/25. Meanwhile, the Capital Gains Tax allowance has been cut from £12,300 to £6,000. For 2024/25, it will be reduced further, to just £3,000.

If you don’t make full use of your allowances in a given tax year, you can’t carry them forward to the next tax year.

2 ways to shield your investments from tax

Whether or not you agree with the increased tax burden on investors, the capital gains and dividend allowances are now much less generous than they used to be. This is why it’s more important than ever to consider tax-efficient investing if you haven’t already done so.

To invest tax-efficiently, there are essentially two ways to go about it. You can either stash your investments in an ISA or opt for a pension.

Let’s dive into these two options…

1. Investing in an ISA.

Anything you invest in an ISA stays tax-free year-after-year. So, hold your investments in an ISA and you won’t have to pay CGT or dividends tax on your returns. This applies as long as you don’t access your investments.

It’s worth knowing investors are limited as to how much they can put into an ISA in any given tax year. This is known as the annual ISA allowance. Happily, for the 2023/24 tax year (at least) this allowance hasn’t become any less generous. This means you can put up to £20,000 into an ISA between 6 April 2023 and 5 April 2024.

For more on how ISAs work, see our article that explains all you need to know about ISAs.

2. Investing in a pension.

A pension is another tax-efficient way to invest.

One downside of pensions is that – unlike ISAs – you can’t typically access your investments early. For example, you can’t access investments held in a workplace pension or SIPP until you’re 55 years old (rising to 58 by 2028). Despite this however, investing in a pension can be a very tax-efficient way to invest, especially if you’re a higher-rate taxpayer. This is because you get tax relief on your contributions, which means that higher-rate (40%) taxpayers have more to gain.

Also, you can take 25% of your pension tax-free once you’re old enough to access your pot. However, you’ll be taxed at normal income tax rates above this amount.

Pensions can be a tad confusing to say the least, so do take a look at our article for all you need to know about pensions if you’re keen to learn more.

Tax-efficient investing through an Investment Trust

While Alliance Trust is sponsoring this article, we’re happy to recommend it as a leading Investment Trust. The company was founded in 1888 and invests in shares globally. It has competitive fees for the industry and uses WTW as its investment manager. WTW is well-known as an investment manager and adviser for large pensions schemes. If you were wondering, an Investment Trust is where a fund manager pools capital from a number of investors with the goal of beating average market returns. Investment Trusts typically invest in a diverse range of assets, such as shares, bonds, and property, although Alliance Trust specialises in shares.

Investment Trusts are ‘close ended’, meaning that fund managers have a fixed amount of capital to invest. This is one big advantage that Investment Trusts have over other types of investing, as fund managers know exactly how much money they have to play with.

Unlike open-ended funds, Investment trusts are also allowed to keep 15% of the income they earn each year to boost dividends during challenging years. This is why many investment trusts have excellent dividend growth track records.

Alliance Trust, for example, is considered a ‘dividend hero’. Not only has paid out 56 consecutive years of rising dividends, but the firm is committed to extending this track record into the future.

If you feel an Investment Trust is right for you, you can place it in a Stocks and Shares ISA.

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Disclaimer: MoneyMagpie is not a licensed financial advisor. Information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. 



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Jasmine Birtles

Your money-making expert. Financial journalist, TV and radio personality.

Jasmine Birtles

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