Tax Free Investments UK

It often comes as a surprise to inexperienced UK investors that they might need to pay some tax on their gains. This might come in the form of capital gains tax and/or dividends tax.

The good news is there are several ways in which you can reduce or completely avoid your tax liability when making investments into shares, ETFs, funds, and other asset classes.

In this guide, we explore the best tax free investments in the UK right now. We’ll discuss the many financial instruments that are worth considering and how to get started with a tax free investment today!

Types of Tax Free Investments

First and foremost, it is important to note that unless you are investing significant amounts, you likely won’t need to pay any tax. This is because everyone in the UK gets an annual tax free investment allowance.

For example, in the 2020/21 financial year, UK investors can earn up to £12,300 in capital gains without needing to pay any tax. This was increased from £12,000 in the year prior, meaning a further increase is likely next year.

In simple terms, this means that you could invest £100,000 into shares – make 12% gains of £12,000 – and you still wouldn’t be liable for any capital gains tax. When it comes to dividends, all UK investors get an annual allowance of £2,000.

Stocks with 0% Stamp Duty

Taking the above into account, we would suggest opting for a stocks and shares portfolio.

In addition to this, the platform charges no monthly/annual maintenance fees and all stock and ETF purchases are 100% commission-free. As a result, by opting for stocks and shares, this is going to be your best tax free investment. The reason being, as long as you do not make ‘realizable’ gains of over £12,300 in the current tax year, you won’t owe a penny to HMRC.

ISAs

When people in the UK search for a tax free investment vehicle, they often opt for an ISA (Individual Savings Accounts). For those unaware, ISAs come in several forms – but the main concept is that they allow you to invest a certain amount each year without needing to pay any capital gains or dividend tax.

In the 2020/21 tax year, this stands at £20,000. In other words, if you have £21,000 to invest this year, the first £20,000 can be placed into an ISA. The remaining £1,000 will need to go into a standard share dealing account.

There are several ISAs available to UK investors, which we explain in more detail further down.

Stocks and Shares ISA

The most popular ISA utilized by UK investors is that of a Stocks and Shares ISA. As the name suggests, this allows you to make tax free investments into the stock markets. With that said, this type of ISA isn’t reserved just for stocks. On the contrary, you can invest in a range of other asset classes.

This includes:

• UK Shares
• International Shares
• ETFs
• Mutual Funds
• Index Funds
• Investment Trusts
• Corporate Bonds
• Government Bonds
• Unit Trusts

As you can see from the above, Stocks and Shares ISAs can be highly flexible, and thus – you can diversify your portfolio with ease. With that said, there is often a misconception that you will be investing your money into a government-backed platform. This couldn’t be further from the truth, as Stocks and Shares ISAs are actually facilitated by traditional online brokers.

For example, you will need to open an account with a platform like Hargreaves Lansdown or IG – both of which offer ISAs. Then, you will need to pick and choose the tax free investments that you wish to make. Once you make the purchase, the asset in question will be added to your Stocks and Shares ISA.

On the one hand, you won’t be liable for any capital gains or dividends tax on the first £20,000 invested with your chosen broker. However – and this point is crucial, you will still need to dealing fees. This is likely to come in two forms.

For example, you need to pay £11.95 for each investment that you make at Hargreaves Lansdown – irrespective of whether or not you are using a Stocks and Shares ISA. In addition to this, you then need to pay an annual fee of 0.45% to the aforementioned broker for keeping the ISA open.

Crucially, taking the above fee-structure into account, we performed some in-depth calculations on whether it’s actually worth opening an ISA.

• You would, however, need to pay a deposit fee of 0.5%. This works out at an all-in fee of £100.
• If we then made a hypothetical assumption that you sold your shares in the same tax year when they were worth £30,000 – this means that you made £10,000 in capital gains.
• We’ll also say that you received £2,000 in dividends. These gains fall below your annual allowances, meaning that you paid no tax on the sale.

When we repeated the above hypothetical example with a Stocks and Shares ISA at Hargreaves Lansdown, we yielded the following results:

• When you bought your UK shares at Hargreaves Lansdown, you paid a dealing fee of £11.95. You also paid 0.5% in stamp duty tax, taking your initial costs to £111.95
• When you sold the shares at £30,000, this again cost you a dealing fee of £11.95. You also incurred an annual maintenance fee of 0.45% to keep your ISA open. We’ll base this on the initial investment of £20,000, so you paid an annual fee of £90
• You did not need to pay any tax on your capital gains or dividends – as you utilized your full Stocks and Shares ISA allowance
• But, you ended up paying a full range of fees – which in total, amounted to £213.90

Lifetime ISA

The next tax free option that you have at your disposal is that of a Lifetime ISA. This particular ISA is suitable for two financial goals – buying your first house or saving for your retirement.

The main attraction here is that the government will boost what you put into the ISA by 25%. This is up to a certain amount each year. In the current tax year, this stands at £4,000 annually. As such, if you put the full £4,00 into this ISA, the government will boost this by £1,000.

In terms of making tax free investments, this works much in the same way as the previously discussed Stocks and Shares ISA. That is to say, you can choose from a variety of stocks, ETFs, funds, and other asset classes. You will, however, need to pick and choose your own tax free investments.

There are several conditions that you need to be aware of when investing in a Lifetime ISA.

For example:

• You must be aged between 18 and 40 to open an ISA
• Any investment made will contribute to your annual ISA allowance. For example, if you invest the full £4,000 into your Lifetime ISA, you will only be able to invest a further £16,000 into a Stocks and Shares ISA in the current tax year
• You can only access your money when you reach the age of 60 or you are buying your first home

Cash ISA

We won’t go into too much detail about Cash ISAs, as in our view, they are not really worth it. Put simply, these are savings accounts that allow you to earn interest on your deposits without needing to pay tax.

However, unless you are looking to deposit a significant amount of money (think 6 or 7 figures), the benefits are virtually non-existent. Sure, you won’t need to pay any tax on the interest you earn, but UK savers get nothing for their money these days.

As such, your money is going to be sat idle in a savings account that is like to yield less much less than 1% per year. In turn, you are effectively losing money when you factor in the rate of UK inflation.

Ultimately, if you are looking to grow your wealth over the course of time, you should consider other UK tax free investments that pay a much higher rate of return.

Junior ISAs

As the name implies, a Junior ISA is a way for you to make tax free investments for your child. This particular ISA allows you to invest up to £9,000 per year. Any gains on the amount you invest will not be liable for tax.

The fundamentals of a Junior ISA work much the same as a Stocks and Shares or Lifetime ISA. This is because you will need to choose which investments you wish to make on behalf of your child. Only your child will be able to access the funds held in this ISA and they must be aged 18 years old.

Pensions

If you’re looking to invest money into the financial markets to grow a nest egg for your golden years, a popular option in the UK is that of a SIPP (self-invested personal pensions). In simple terms, SIPPs allow you to invest in your future in a tax-efficient manner. You will, however, be required to choose investments on a DIY basis.

While this won’t suit all investors in the UK, it will if you want to take full control of where your money goes. Once again, in order to access tax free investment options in the form of pensions, will you need to go through an online broker. The same rules apply in terms of fees – meaning that you will need to pay a commission when you buy and sell investments.

In most cases, you will also incur an annual maintenance fee for keeping the SIPP open. On the flip side, this still can work out much cheaper than using a traditional pension provider. After all, you will not be taking investment advice and your portfolio is not actively managed. Instead, you decide which assets and buy and when.

Much like the previously discussed Stocks and Shares ISA, SIPPs give you access to a full range of tax free investments. There are, however, a few limitations. For example, ETFs can only be invested in if they are listed on an exchange in the UK or Europe.

Additionally, while you can invest in bonds issued UK and foreign governments, you can only buy corporate bonds listed in the UK. SIPPs do give you access to several assets that ISAs do not. For example, you can invest in offshore funds, REITs, and even commercial property.

Tax Free Benefits of SIPPs

When it comes to the specific tax free benefits of opting for a SIPP, this follows the same principals as a conventional pension plan. That is to say, you can invest up to 100% of your annual salary – which is capped at £40,000 in each tax year.

In terms of accessing your money, you will need to wait until you are of retirement age. Throughout the cycle of your SIPP investment journey, you won’t pay any tax up to your annual limit.

Venture Capital Schemes & Trusts

This particular tax free investment idea takes somewhat of an ‘outside the box’ approach. This is because you will be investing money into Venture Capital Trusts (VCTs). For those unaware, VCTs are listed on an exchange and operate like a conventional fund.

However, they focus almost exclusively on small, up and coming UK companies that are still private. In other words, the companies that VCTs invest in are not publicly-listed and thus – you wouldn’t be able to buy shares in them. On the one hand, by indirectly investing in new and innovative companies, you stand the chance to get in early.

This means that the growth potential could be huge – especially if the said company one day makes it onto a public stock exchange. On the other hand, these companies usually have unproven business models. They are lacking in the free cash flow department, which is why they raise capital from VCTs.

From your perspective, this means that the risks of investing in VCTs are much higher risk than a traditional asset like blue-chip stocks or ETFs.

How Venture Capital Trusts Work

Much like a traditional fund, VCTs will collect money from thousands of individual investors. You will need to make your tax free investment through a suitable broker. The VCT will then determine which companies to inject capital into – meaning that you can benefit from a passive form of investing.

There are several things that you need to understand about VCTs before you invest, such as:

• In order to benefit from a tax-efficient investment, you must invest in a newly-issued VCT. If you invest in one that is already active, no tax benefits will apply.
• The tax relief that you will get by investing in a VCT stands at 30% (up to a maximum of £200,000 annually). This 30% relief can then be used to offset your overall income tax liability.
• To ensure you get this 30% tax relief, you will need to keep hold of your investment for at least five years. Should you decide to exit your position early, you won’t get the aforementioned tax relief.

With that, the overarching benefit of VCTs is that you will not pay any capital gains tax on your profits. This is the case irrespective of how long you invest for, meaning they are a great tax free investment to consider.

Enterprise Investment Scheme & Seed Enterprise Investment Scheme

In a somewhat similar nature to VCTs, the Seed Enterprise Investment Scheme seeks to encourage UK investors to invest in small domestic companies. The scheme was first introduced by the government in 2011 and it aims to promote and boost the small-to-medium business sector.

Once again, as these firms operate largely unproven business models, the risk and reward spectrum is going to be much higher. In full recognition of this, the UK government offers several tax-efficient benefits when you invest in companies that take part in the Seed Enterprise Investment Scheme.

This includes:

No Capital Gains

When you invest in the Seed Enterprise Investment Scheme, none of your financial returns will be liable for capital gains. This is very welcome news for those of you that wish to make UK tax free investments.

With that said, you do need to hold on to your investment for at least three years to benefit from the capital gains tax exemption. If you exit your investment early, standard tax rates apply.

Income Tax Relief

By investing in the Seed Enterprise Investment Scheme, you will also be able to build some relief on your overall income tax bill. The amount of relief that you get amounts to 45% of your total investments. If this brings your income tax bill to zero for the current tax year, you can also use any surplus relief for the previous tax year.

Capital Gains Tax Relief on Other Investments 

In addition to the above, the Seed Enterprise Investment Scheme also allows you to reduce some of the capital gains tax that you would have ordinarily had paid on other investments. This stands at 50%.

For example, let’s suppose that you sell some UK shares and your capital gains amounted to £5,000. If you were then to reinvest this £5,000 into the Seed Enterprise Investment Scheme, you would reduce your capital gains liability on the share sale by 50%.

Loss Relief

Any noted above, investments into companies that take part in the scheme are much higher risk. As such, the scheme allows you to offset some of your losses against your overall income tax bill. In some ways, this offers a level of protection against investment losses if your income tax bill is somewhat high.

Inheritance Tax Relief

Finally, by holding onto your Seed Enterprise Investment Scheme position for at least two years, your beneficiary will be exempt from paying any inheritance tax on the sale of the investment.

Enterprise Investment Scheme

While the above has focused on the Seed Enterprise Investment Scheme, tax free investments can also be made via the Enterprise Investment Scheme (EIS). This works much in the same way, as you will be investing in small UK startups. In return for backing eligible companies, you’ll benefit from tax relief in the form of capital gains, income tax, inheritance tax, and losses.

What Tax do You Pay on Investments in the UK?

So now that we have covered the best tax free investments in the UK right now, it is important for us to quickly explain what tax you would ordinarily need to pay.

Stamp Duty

When you invest in companies listed on the London Stock Exchange, you are required to pay stamp duty. As noted above, this is charged at 0.5% of the amount you invest. The broker will charge you directly when you invest and then forward the funds to HMRC.

Capital Gains

We have mentioned capital gains tax several times throughout this guide, but are yet to explain exactly how this works. In simple terms, capital gains refers to the profit that you make from an investment. For example, if you buy £2,000 worth of shares and sell them when they are worth £2,500 – your capital gains amount to £500.

This £500 is what could be liable for capital gains tax. However, as we noted earlier, you can make gains of up to £12,300 in the current UK tax year without the proceeds being liable for tax. In other words, anything about the £12,300 threshold will be liable for capital gains tax.

For example:

• In April 2020, you buy £10,000 worth of Tesla shares at a stock price of $100 each
• In March 2021, Tesla shares are worth $400
• This means that your £10,000 investment is now worth £40,000
• You decide to sell your shares to cash in your profits
• Your capital gains amount to £30,000
• Of this figure, £12,300 can be dedicated as this is your annual capital gains tax free allowance
• This means that £17,700 is liable for capital gains tax

Once you know how much is liable for capital gains tax, you then need to assess what your current tax band is. This is because the specific rate will vary depending on whether you are a basic or higher rate taxpayer. If it’s the former, the rate is 10%. And the latter – 20%.

So, assuming that you are a basic rate taxpayer, in the above example where you made £17,700 from your share sale, you would owe £1,770 to HMRC.

Dividends

If you find yourself making dividend investments – such as shares or ETFs, then you might need to pay tax on your income. Before we get to that, we should note that all UK investors can earn £2,000 per year in dividends without being liable for tax. Anything after this will attract dividend tax unless you invest in an ISA.

The rate that you pay once again depends on your current tax band:

Basic rate: 7.5%
Higher rate: 32.5%
Additional rate: 38.1%

For example:

• Let’s suppose that you invest £30,000 in dividend stocks
• In the 2020/21 tax year, you receive an annualized dividend yield of 10%
• This means that you received £3,000 in dividends
• The first £2,000 will not be liable for tax, meaning that it’s just the balance of £1,000 that is
• You are a basic tax-rate payer, so you pay 7.5%
• This means that your total dividend tax bill for the year is £75

Note: Don’t forget – all UK residents get an annual income tax rate allowance too. This means that if dividends is your main source of income, you could benefit from even greater tax free allowances. 

Best Platforms to Invest in Tax Free Investments

So now that we have covered everything you need to know about UK tax free investments, we now need to discuss share dealing platforms. After all – whether that’s stocks, ISAs or any tax free investment class for that matter – you need an online broker to execute your trades.

There are hundreds of such brokers to choose from, so you need to do some homework to find one that best meets your personal financial goals. But, if you don’t have time to research a platform yourself, below you will three of the best UK share dealing platforms to make tax free investments.

1. Hargreaves Lansdown – Best Broker for Tax Free ISA Investments

Hargreaves Lansdown is a popular UK broker with 1.3 million clients. It is often the go-to broker for newbies as the platform is simple to use. It also comes jam-packed with research materials that assist you in the investment decision-making process.

The reason that Hargreaves Lansdown makes the cut for us is that it offers fully-fledged ISAs. This includes ISAs in the form of Stocks and Shares, Lifetime, and Junior accounts. You can use the platform to invest in heaps of asset classes. This includes UK and international shares, ETFs, funds, and investment trusts. All ISAs at Hargreaves Lansdown come with an annual fee of 0.45%.

If you decide to invest in mutual funds or ETFs, additional expense ratios will apply. You will also need to factor in the platform’s share dealing fee of £11.95 per trade. This does make Hargreaves Lansdown an expensive option. This Financial Conduct Authority broker is a safe bet though, as its reputation in the UK investment scene is top-notch. Not only are your funds protected by the FSCS, but the broker is now listed on the London Stock Exchange.

Hargreaves Lansdown fees:

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3. IG – Trusted UK Trading Platform With 16,000+ Investment Assets

Much like Hargreaves Lansdown, IG is an old-school stock broker with a great reputation in the UK. By opening an account and meeting a £250 minimum deposit, you will have access to over 16,000 assets. This includes ETFs, stocks, mutual funds, and trusts. All of these assets can be added to a Stocks and Shares ISA at IG.

In terms of fees, the IG Stocks and Shares ISA will cost you £8 per trade or £3 per trade when placing three of more orders in the previous month. If investing in shares listed in the US, you can do this commission-free if meeting the aforementioned minimum.

Otherwise, you will pay £10 per trade. Alternatively, you might also consider the IG Smart Portfolio ISA. In doing so, your portfolio will be pre-selected by IG. The minimum investment on this ISA option is £500. You can add funds at IG with your debit or credit card to benefit from an instant deposit. Finally, IG is covered by the FSCS and licensed by the FCA.

IG fees:

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Conclusion

As we have uncovered in this guide, there are many tax free investments that you can make in the UK. Crucially, this allows you to keep more of your investment profits. Although you might be tempted to invest via a Stocks and Shares ISA, better alternatives exist from a cost-effectiveness perspective.

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