Tax year end: Six ways to invest a £100,000 bonus
Next week marks the end of the 2022/23 tax year, with midnight on 5 April the deadline for using available tax-free savings and investment allowances.
Last December saw city workers awarded bumper bonuses and seven in ten City workers still expect their bonus to be as large as – if not ‘larger’ or ‘significantly larger’ than last years.
Alex Davies, chief executive and founder of Wealth Club, said that, irrespective of the size of the bonus, “one thing is almost certain – tax will need to be paid on it”
And with the forthcoming tax changes from 6 April, that tax haircut is bound to be sizeable. Investing any bonus money as tax-efficiently as possible has never been more important.
Davies outlines six ways you can invest your bonus, in schemes and accounts that can save you tax.
One: Invest up to £40,000 bonus in a pension
Most employers offer a ‘salary sacrifice’ option, explained Davies. “Despite the somewhat off-putting name,
it simply allows you to send part, or all of your bonus straight to your pension. Not only could you save income tax (45 per cent, if you are a top-rate taxpayer), but you could also save National Insurance.
“This tax year most people can put as much as they earn into a pension, capped at £40,000 a year. However if you earn more than £240,000 this is gradually tapered down to as little as £4,000.”
From April 6 2023, the pension allowance increases for most people to £60,000, although a taper will remain for those earning more than £260,000 reducing their allowance to as little as £10,000.
There is currently a lifetime allowance (LTA) of £1,073,100. This is being removed from 6 April so there is no cap on the value of the pension you can build after that date.
Davies warned: “In practice you may want to think twice before building a massive pension. When you retire, you can take 25% (up to £268,275, equivalent to 25% of £1,073,100) tax free, whilst the rest is taxed like income. So, the more you go over £1,073,100, the greater proportion of your pension will be subject to tax when you take it out.
Two: Invest up to £20,000 in an ISA
Once you have ticked off the pension, using your full £20,000 Isa allowance is the natural next step. You don’t get tax benefits on the way in, but you do on the way out – no tax on income or withdrawals- plus any growth is tax free.
If you are aged under 40, you may want to split your Isa investment between a stocks and shares Isa and a Lifetime Isa.
“Lifetime Isas can be a no-brainer.,” added Davies. “You can invest up to £4,000 a year until you turn 50 and when you do the government tops it up with £1,000, a 25 per cent boost. There are, however, a few strings attached. Broadly speaking, you can only withdraw money if you’re buying your first home or are aged 60+ (a 25 per cent withdrawal charge might otherwise apply).”
Three: Invest £40,000 to £80,000 into early-stage businesses through venture capital
Once your ISA and pension are done, the next best thing – and an increasingly popular choice amongst experienced investors – are the government-backed venture capital schemes: venture capital trusts (VCTs), the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
“Not only are they highly tax efficient but they could also add something different to an investment portfolio of funds and shares listed on the main market,” said Davies.
“Through VCTs, EIS and SEIS you can get exposure to young, ambitious and fast-growing companies – some of which may become tomorrow’s household names – and receive income tax relief of up to 50 per cent.
“You need to remember these are riskier and more illiquid than mainstream investments and therefore only for experienced investors. But that’s why the government offers such generous tax reliefs. As with any investment, it also helps if you spread your money over different investments. “
Four: Invest your bonus in VCTs
With VCTs, you invest in a listed company which, in turn, invests in young fast-growing businesses chosen by a fund manager. So, a single investment gives you exposure to a portfolio of 50-100 businesses.
You can invest up to £200,000 each tax year and get up to 30 per cent income tax relief. Most returns come through dividends which are tax free, as is any growth. To keep the tax relief, you must hold a VCT for at least five years.
Five: Invest your bonus in an EIS
With EIS, you invest directly in young and ambitious companies that you choose yourself or that a fund manager chooses on your behalf. Typically, an EIS fund will give you exposure to 5-15 companies, so it’s more concentrated – and hence higher risk – than a VCT. But in recognition of this, the tax reliefs are more generous. You can invest up to a £1m – £2m in some cases- each tax year and receive income tax relief of up to 30 per cent. In addition, any growth is tax free; you can also defer taxable gains you might have made elsewhere and the resulting CGT bill; and the investment should be IHT free if you hold it for two years and on death.
Lastly, if you lose money on your EIS investment, you can write the loss off against your tax bill in the year you make the loss. So if a £10,000 investment resulted in a total loss, once you take into account all the tax reliefs, the most a 45 per cent taxpayer could lose is £3,850. To keep the tax relief you must hold an EIS investment for at least three years.
Six: Invest in SEIS
SEIS is designed to provide the first capital to help young and ambitious companies get off the ground. You can choose the companies yourself or let a fund manager choose on your behalf. Typically, an SEIS fund will give you exposure to 10-30 start ups. Statistically, most start-ups fail, making the SEIS the riskiest of the three schemes but also the one with the most generous set of tax reliefs. You can invest up to a £100,000 (doubling to £200,000 from 6 April) and receive income tax relief of up to 50%. In addition, any growth is tax free; you can also receive up to 50 per cent CGT relief on taxable gains you might have made elsewhere; and the investment should be IHT free if you hold it for two years and on death.
If you lose money on your SEIS investment, you can write the loss off against your tax bill in the year you make the loss. So if a £10,000 investment resulted in a total loss, once you take into account all the tax reliefs, the most a 45% taxpayer could lose is £1,350. To keep the tax relief you must hold an SEIS investment for at least three years.