Investments can seriously affect your tax bill!

Choosing the best investment is difficult enough. You want an investment that gets you the best return. It can be difficult to predict if stocks and shares will go up or down, or whether a guaranteed fixed rate of return will be the best for your money. On top of that, and what many people forget, are the tax issues which, if overlooked, could leave you worse off.

Take, for example, investment bonds. Many people think that these are a tax free investment and a simple solution for many, in particular pensioners. Although investing in such bonds may be suitable for many, it is difficult to confirm this without first addressing all of the tax issues.

First of all, let’s take the ‘tax free income’ of up to 5% that you can withdraw each year. This is actually a withdrawal of the initial investment which is treated as a return of the original capital and so not taxable. Where higher amounts are taken then this is treated as income and often referred to as a chargeable event. ‘A chargeable event’ also arises on encashment, sale or death of the policyholder. Many people wrongly think that chargeable event uses your annual capital gains tax allowance.

The income comes with a tax credit so, if you are a basic rate taxpayer, there may be no further tax to pay. However, where the chargeable event, together with your other income, exceeds the basic rate band then additional tax will become due on some or all of this income. In other words, you will face a tax bill of up to 20% of the income.

The over 65’s , on the other hand, can be caught out even if their total income including the bond is within the basic rate band. The current level of income an over 75 can receive free of tax is currently £9,180. This is their personal allowance and is the amount of income they can receive before they start to pay tax.

If their total income exceeds £21,800 then this personal allowance can drastically reduce. A chargeable event can reduce their personal allowance, thereby increasing their tax burden, despite their income not hitting the higher rates of tax. This could result in extra tax of up to £629 each year.

Income from a bond can also seriously reduce the amount of tax credits available. Even a small chargeable event that results in no extra income tax could wipe out up to 39% of the tax credits payable.

Tip: Before taking out an investment, consider the tax issues on the investment and your returns. Consider if the investment will increase your tax bill, affect your age allowances, or even reduce the amount of tax credits that you are entitled to.

Couples should always consider in whose name the investment should be. For example if one is a higher rate tax payer then tax savings could be made by making the investment in the other’s name.

The other thing to bear in mind is the type of investment, and how the return you make is taxed. Higher rate taxpayers for example may well prefer to invest in assets that give a capital growth as opposed to annual income in order to achieve tax savings.