What about tax?

Tax is a fact of life and we all have to pay what’s due, so it’s good to know that you could benefit from tax savings when investing.

To help you understand, here’s a very quick overview of some of the taxes you might come across if you do decide to invest, and the potential tax savings that go with them.

But before we start you should be clear that tax rules, who is eligible to benefit from different tax allowances and how they apply to you personally is a detailed area, so you can’t just rely on what we say here. Be sure to investigate your own circumstances before making any decisions.

You can find out more about taxes on the gov.uk website. That includes all the latest tax rates and tax allowances that might be relevant for your personal circumstances.

Now we’ve cleared that up, there are areas of tax you should be particularly aware of when investing - income tax, capital gains tax and inheritance tax.

Income tax

If you’re working, there’s a good chance you already pay income tax on your earnings.

When you invest you may also earn income from your investments. And if you do, you might have to pay income tax on that too.

The types of income you can earn from investments include dividends from shares, interest payments from bonds and distributions from funds. Distributions are where a fund passes on your share of any income it earns.

If you are able to invest in an Individual Savings Account, or ISA, then you won’t pay tax on any investment income or investment gains you make in that ISA. You can currently put up to £20,000 into an ISA each tax year.

We’ll talk more about this important way of saving tax later on.

It’s also worth being aware of the dividend allowance and the personal savings allowance, for any savings or investments you don’t hold in an ISA.

The dividend allowance lets you receive up to a set level of dividends, free of income tax, in each tax year. And, depending on your circumstances, the personal savings allowance potentially lets you receive up to a set level of interest from investments and savings, free of income tax, in each tax year.

Distributions from funds can potentially count towards either allowance.

Capital gains tax

Capital gains tax is something you might have to pay if you sell some types of asset for a profit. That can include things like a second property and art, as well as certain types of investment.

Broadly speaking, profit is the amount your asset increased in value since you bought it, without counting any income it might have paid out to you, since that is already covered by income tax.

Types of investment you may have to pay capital gains tax on may include, for example, any shares and funds that you don’t have in an ISA.

On the plus side there is also an annual tax free allowance for capital gains. Each tax year you’re allowed to make a total profit up to that annual allowance without paying tax.

Inheritance tax

Your family may have to pay this after you die if you leave assets worth more than a certain amount, including investments, and depending on who you leave them to.

There are various possible ways you can aim to manage any future inheritance tax bill for your family, but that’s a whole separate subject we won’t go into here.

So those are some of the taxes to be aware of when investing.

Tax savings

When it comes to tax savings, as well as the allowances we’ve already mentioned, there are a couple of biggies worth knowing about.

Investing through a pension

You may be getting one already without realising it. If you invest through a pension that’s offered by your employer, you’ll be benefiting from tax relief which acts to boost the amount you invest. You don’t have to pay income tax or capital gains tax on any investments in your pension and in many cases pension investments can be passed on free of inheritance tax too.

With pensions, you can’t generally access your investments until you are at least 55 but you can then potentially take out up to a quarter of your money tax free.

Investing through an ISA

The other well-known way to benefit from tax savings allowances is by investing through an ISA.

There are four types of ISA – stocks and shares ISAs, cash ISAs, innovative finance ISAs and lifetime ISAs. Most of the more popular investments (like shares and funds) can be held in a stocks and shares ISA.

You don’t have to pay income tax or capital gains tax on any income or profits from investments held in an ISA. You can also access your investments at any time (although it’s generally not a good idea to invest at all if you’re looking to do this within five years).

You can currently invest up to £20,000 in an ISA each tax year, making them an obvious first port of call for anyone looking to invest outside of a pension. You can split this annual allowance across a cash, innovative finance, lifetime and stocks and shares ISA but can only pay into one of each type in any one tax year, up to the annual ISA limit.

You can also transfer any money you have already paid into other ISAs from one type to another – for example from a cash ISA to a stocks and shares ISA if you’re hoping to make your money work harder for you by investing it – without affecting the amount you can still pay in to an ISA that tax year.

You can transfer all or some of the money you paid in to ISAs in previous tax years. If you want to transfer any money you have invested during the current tax year you have to transfer all the money you’ve paid in so far.

So it’s worth keeping both pensions and ISAs in mind as a way to invest.

Using your tax allowances makes sense

You’ll want to give yourself the best possible chance of building up a decent sum over time so it makes sense to use the available tax allowances where you can.

As we finish, it’s worth remembering that tax rules can change at any time and how they affect you always depends on your individual circumstances. If you’ve already amassed a large sum of money, it might be a good idea to seek professional tax advice.

Now that you’ve learned a little bit about tax and investing, it’s time for a recap of some of the key points we’ve covered in New to investing?