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Four tax-efficient investments for the new financial year

There is never a better time than the beginning of the tax year to take stock of your financial affairs and ensure that your money is providing a maximum possible return. It is important to ensure that you are not paying too much tax, and that you make the most of the various tax-saving allowances that are available. But with complex legislation surrounding tax-efficient investments, it can be hard to know where to start.

Until recently, the main ways to make an efficient tax investment were venture capital trusts, enterprise investment schemes, ISAs and pensions. These have just been joined, for this financial year, by seed enterprise investment schemes.

1. Invest in a venture capital trust or enterprise investment scheme

Suitable investors willing to take a high level of investment risk can put capital into smaller companies through venture capital trusts (VCTs) or enterprise investment schemes (EISs). The trusts and schemes are available from specialist investment firms, usually based in the City, although an independent financial adviser (IFA) can advise on which companies offer what. If you've got a particular interest – such as ethical investments, funding the creative industries, green power or even medical funds – you can divert your money into a specific area.

VCTs and EISs must invest in smaller companies in order to qualify for their tax-efficient status. Under current rules the main condition is that the schemes are limited to investing in companies with gross assets of less than £7m before, and no more than £8m after, the investment and must have less than 50 full-time equivalent staff. The criteria for qualifying investments are very strict, including restrictions on the type of business that can be invested in, and ultimately limit investment to smaller and developing companies. As a consequence, these investments are deemed to be high risk and this must be considered very carefully.

As shown in the table (see above right), you can invest up to £200,000 – although a smaller sum such as £10,000 is recommended. In return for making an investment, you receive tax relief – after recent changes the relief available is similar for VCTs and EISs, but there are a few significant differences between the two products. The table highlights the main reliefs available.

For the 2011/12 tax year, both VCTs and EISs provide income tax relief of 30%. Tax relief is given as a repayment of income tax paid and therefore the amount of relief available is restricted to how much income tax you've actually paid – it's perhaps better to think of the money as a reclaim rather than a relief. The money is claimed back through the self-assessment tax return, which most GPs file, and it's important to remember to claim what you're entitled to – otherwise the benefits of investing in a high-risk product might be lost.

Tax relief is due from the day you invest, but if you sell your investment back before the holding period is up you must pay back all the tax relief you received. For instance, if you invest £20,000 today you receive £6,000 in tax relief straight away. But if you sell your investment back after two years, you must pay back £6,000. While the level of income tax relief is the same, there are differences between VCTs and EISs and these may mean that one is more suitable than the other, depending on your personal circumstances. Bear in mind that if you hope to get a capital gains tax deferral – for instance, if you make a significant sum selling a house, want to reinvest the money and defer the associated capital gains tax – you can use an EIS to do so, but not a VCT.

2. Seed enterprise investment schemes

Launched at the start of the current financial year, seed enterprise investment schemes (SEISs) are the Government's latest tax-incentivised scheme to encourage investment in new, smaller companies.

Similar in structure to EISs and VCTs, individuals can invest up to £100,000 in a single tax year, rising to up to £150,000 over two or more tax years, in a single company.  Income tax relief is given on the amount invested at a rate of 50%.

Again, there are investment restrictions. The company must be unquoted – not listed on a stock exchange – have 25 or fewer employees and assets under £200,000 at the point you invest. It must also be undertaking a new business. These companies are very small indeed. You couldn't invest in a property-owning business such as a practice, for example – options that spring to mind are specialist technology or design companies, such as architecture firms. SEISs involve a higher level of investment risk than their close relations, EISs and VCTs, which is why they carry greater tax relief. Investors should weigh up the risks and the potential benefits.

3. Use your ISA allowance

Individual savings accounts (ISAs) are still a perennial favourite thanks to the fact they're a low-risk, tax-free savings product. For people aged 18 and over, the ISA allowance for the 2012/13 tax year is £11,280, of which up to £5,640 can be held in a cash ISA, with the remainder invested in a stocks and shares ISA. If you don't want to save into a cash ISA, the whole allowance can be used in a stocks and shares ISA.

We all know that ISAs are a tax efficient way of saving and investing and while it might seem a bit of a pain moving relatively small amounts into ISAs each year, the cumulative benefits over the years can be significant. It is worth noting that the allowance is personal, so a couple could place up to £22,560 during the current tax year into ISAs.

While ISAs don't give any immediate tax relief, the interest generated is free from tax, though the 10% tax credit on UK equity dividends can no longer be reclaimed. Many people hold their savings and investments inefficiently and, from a taxation point of view, the message for ISAs is clear: use your ISA allowance each year as it's one of the safest ways to invest.

4. Plan your pension

Pension planning should form an important part of everyone's financial plans. The taxation allowances are significant, though with constantly changing legislation and the complexities of GPs' NHS Pension Scheme, ensuring you don't fall foul of the rules is difficult.

Contributions to registered pension schemes qualify for tax relief at the individual's highest rate of income tax. For 40% and 45% taxpayers the relief given is obviously significant.

In addition, investments held within pension funds grow in a largely tax-free environment.

Bear in mind both the annual and lifetime allowances. When the Government reduced the annual allowance (the amount you can pay into a pension and receive tax relief on) for the 2011/12 tax year from £255,000 to £50,000, it also introduced a carry-forward to allow people to use the previous year's unused allowance.

The current year's allowance is used first and then you can go back and mop up three previous years' unused allowances, providing you have sufficient earnings in the current tax year to justify the level of contributions.

For members of the NHS Pension Scheme the amount of contribution tested against the £50,000 annual allowance is not the amount paid in superannuation contributions.

It is the growth in pension benefits over the tax year, multiplied by a factor of 16, plus the growth in any lump-sum benefits, allowing for an inflationary increase. Any further pension contributions – such as FSAVCs, personal pensions and so on – are included in the £50,000 allowance in addition to the NHS scheme. 

For GPs, this figure is important but very difficult to accurately predict. Great care should therefore be taken if you are looking to make a pension contribution. Total contributions in excess of the annual limit will be taxed at the individual's marginal tax rate (or rates), determined by adding the excess contributions to the individual's income.

In addition to the annual allowance there is a lifetime allowance on the amount of any individual's tax-exempt pension savings. This limit has now reduced and is currently £1.5m in the 2012/13 tax year. Any excess over this lifetime limit is subject to a lifetime allowance charge of 25% tax before being used to provide taxable benefits or, if the excess is taken as a lump sum, it is taxed at 55%.

Gareth Rose is a chartered financial planner at Moore and Smalley Healthcare Services, and a member of the Association of Independent Specialist Medical Accountants