Tax & Pensions Clinic: Our reader is wondering whether he should use a general investment account after exhausting his pension
Matt Sellens, managing director of Crown Wealth Consultants, says:
Congratulations on reaching a strong financial position. Now, let’s explore your options for further investments once you've maximised your pension and Isa allowances, and compare their tax implications to determine the most efficient strategy. As you say, one option is to make pension contributions above your annual allowance. The annual allowance for pensions normally limits the amount you can contribute without suffering a tax charge to £60,000. However, if your adjusted income exceeds £260,000, your annual allowance tapers by £1 for every £2 above that threshold. Investing further into a pension has some advantages: your portfolio grows tax-free, which enhances its long-term value, and pension assets generally don’t fall into your estate, so they can be passed to beneficiaries free of inheritance tax (IHT).
However, depending on whether you pass away before or after the age of 75, beneficiaries may pay income tax at their marginal rate on withdrawal. You also can’t access your pension until at least age 55 (rising to 57). This could help if you’re prone to dipping into your investments and want to avoid the temptation, but depending on your age it could mean being unable to use the money for many years. If you exceed the allowance, you will face an annual allowance tax charge at your marginal rate (likely to be 45 per cent), which nullifies any tax relief you may receive on the contributions. Moreover, 75 per cent of your withdrawals are taxed as income, reducing the tax efficiency of these contributions. The remaining 25 per cent of withdrawals is normally tax-free, but keep in mind that the pensions tax-free lump sum is currently capped at £268,275. If you build up a big pot and hit this cap, it may reduce the appeal of saving more into your pension. Meanwhile, a general investment account offers flexibility and full access to your funds at any time. While there is no tax relief on contributions, it allows you to use your CGT annual exemption, currently £3,000. You can also transfer assets to a spouse or civil partner to use their exemption, potentially minimising tax.
Investments that result in a capital gain are taxed at 10 per cent or 20 per cent depending on your tax bracket, which may be lower than the rates applied to pension withdrawals. However, the CGT allowance has decreased over the past few years, and CGT rates could be increased by the government in the Autumn Budget. Dividends and interest earned in a general investment account are also subject to income tax. Finally, you could look at investing in venture capital trusts (VCTs) and enterprise investment schemes (EISs). Both offer attractive tax reliefs but come with significantly higher risks. VCTs offer 30 per cent income tax relief on investments up to £200,000 if held for at least five years, along with tax-free growth and dividends. However, these investments are in high-risk, small, unlisted companies, leading to potential volatility.
EIS investments also provide 30 per cent income tax relief up to £1mn (increasing to £2mn if at least the second million is invested in knowledge-intensive companies) after a three-year holding period. They also offer CGT deferral and loss relief. EIS investments qualify for business relief, making them IHT-free if held for at least two years at the point of death. Like VCTs, they are high-risk, often illiquid, and primarily suited to those with a high risk tolerance.
When deciding where to invest, consider your goals, objectives, attitude to risk, and the timeframe for accessing your funds. Each option presents different benefits. For flexibility and accessibility, a general investment account may be best, especially if CGT rates remain lower than income tax rates. However, future changes in CGT rules could affect this strategy. For estate planning, pensions have an advantage as they are generally excluded from your estate for IHT purposes, even if contributions exceed the annual allowance. If you have a high risk tolerance, you could allocate a small portion of your portfolio to VCTs or EISs, in order to benefit from tax reliefs and potential CGT deferrals. However, this should be supplementary to a more conservative core investment strategy.
