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Tax Efficient Investing

Everyone in the UK aged 18 or over has an annual individual savings account (ISA) allowance each tax year. For the 2021/22 tax year this is £20,000. The tax year runs from the 6th of April to the 5th of April each year. If you are not from the UK then the information I am about to cover will not be applicable to you. However, your own country will likely have their own tax efficient schemes for investing, so I would strongly check them out before investing any of your money into the stock market. 

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Stock Market Data

 

The 3 main types of ISAs in the UK are: 

- Cash ISA

- Stocks and Shares ISA

- Lifetime ISA

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The only ISAs that are worth considering placing any of your money are a stocks and shares ISA or a lifetime ISA. A cash ISA is simply a savings account in which you don't pay any tax on the interest earnt. Interest rates on these accounts are so low that no providers currently offer a rate above 1% for easy access cash ISAs. If you are happy with pathetic returns then a cash ISA may be for you. 

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Stocks and Shares ISA

If you invest in the stock market through a stocks and shares ISA you are exempt from the following 3 taxes:  

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1. Capital Gains Tax (CGT)

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Capital gains tax would only apply if you sold your shares for more than you brought them for and had already used up your capital gains allowance (£12,300 for the 21/22 tax year). For example, if you paid £5,000 for some shares and sold them for £7,500 you would have made £2,500 profit. If your CGT allowance had been used up already then this profit would be taxed at 10% (£250) if you were a basic rate tax payer or 20% (£500) if you were a higher or additional rate tax payer.

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2. Tax on Dividend Income

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Dividend income is received when companies decide to pay out a proportion of their profits to shareholders. Each tax year there is a dividend allowance of £2,000, with dividends received above this amount liable to tax at either 7.5%/32.5%/38.1% depending on the tax band you are in.

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3. Income tax on Corporate Bonds Interest

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You won’t pay any income tax on interest from corporate bonds. I know corporate bonds are not stocks but it is worth mentioning as your portfolio may have some within it, especially if you are nearing retirement or already in retirement. 

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Other Key Things to Note

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- You can only set up one stocks and shares ISA with one provider each tax year. You cannot set up a stocks and shares ISA with two different providers in the same tax year. If you have multiple different stocks and shares ISA accounts that you have set up over the years then it is also important to note that you cannot pay into more than one stocks and shares ISA in the same tax year. You can pay into different ISA accounts in the same tax year. For example, you can put money into a cash ISA a lifetime ISA and a stocks and shares ISA all in the same year because they are different types of ISA accounts.

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- If you have used up all of your ISA allowance for the tax year but your partner has not then this could be a good use of any excess cash. 

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