Investment risk and taxation are two crucial factors which investors need to consider when building successful portfolios. Both have the potential to diminish returns and derail investors from their goals. Yet how can they be addressed prudently?
Below, our Carlisle financial advisers offer a short guide to investment risk and taxation and how they impact portfolio decision-making. We discuss how private and corporate clients can address them across different asset classes using efficient strategies grounded in time-honoured principles.
We hope these insights are helpful. Please contact us for more information or to speak with a financial adviser:
t: 01228 210 137
e: [email protected]
Taxes and Investment Returns
Taxes play a crucial role in shaping investment returns and influencing investor decisions. In particular, capital gains tax (CGT) can apply across many asset classes when investments are sold for a profit.
To mitigate needless investment taxation, investors should consider the timing and structure of their investment transactions. For instance, spreading “asset disposals” which would be liable for CGT across multiple tax years can allow investors to maximise their CGT-free allowance (Annual Exempt Amount) each financial year. In 2024-25, the Annual Exempt Amount now stands at £3,000 per year.
Tax-efficient investment “vehicles” can also be useful for structuring varying investment classes. Assets held in an ISA can generate tax-free interest, capital gains, and dividends. An individual can contribute up to £20,000 to their ISAs each tax year.
Pensions can also be a powerful “wrapper” for generating tax-efficient investment returns. Investments within a pension are free from capital gains tax when sold. When combined with the tax-relief available on pension contributions, this can provide a large boost to your retirement savings and potential income in retirement.
Types of Investment Risk
It would be impossible to fully explain all types of investment risk in one short guide to investment risk and taxation. However, here are four to consider:
- Credit risk (how likely is it that a borrower – e.g. a company – will default on its debts?).
- Liquidity risk (how difficult is it for investors to buy and sell the investment?).
- Market risk (to what degree will the investment be affected by broad factors like economic downturns, geopolitical events and other fluctuations?).
- Interest rate risk (would a shift in the base rate impact your investment and asset classes?).
Investors can take various steps to address each type of investment risk. Perhaps the most crucial step is diversifying holdings appropriately.
Each investment will suffer these four risks (and others) in different ways. They will also have their respective strengths. By “spreading out” your holdings with the help of a financial adviser, you can offset some of these weaknesses and reinforce areas of strength.
Inflation, Investment Risk and Taxation
Investors sometimes forget about the “silent killer” of investment returns—inflation (the rise in the general price level in the economy). Indeed, it is possible for your investments to appear to be growing “on paper,” yet if Consumer Price Index (CPI) inflation outstrips your returns, they will lose their real spending power.
Inflation can also affect investors’ tax bills. If prices are rising fast, workers often demand pay rises to retain the value of their incomes. However, if tax bands are frozen over a long period (as they have been in the UK for some time), eventually, taxpayers could find themselves pushed into higher income tax brackets. This, in turn, could result in higher taxes on their investments. As such, seek financial advice to enhance vital knowledge and build an efficient tax plan.
The Long-Term: IHT, Investment Risk and Taxation
Do you intend to leave your wealth to loved ones or “good causes” when you die? Inheritance tax (IHT) can inhibit many investors’ estate plans if they are not careful. However, by planning far in advance you can maximise control over what eventually happens to your assets.
In 2024-25, pensions are often a powerful retirement and estate planning tool. During a career, an individual can benefit from tax relief on their pension contributions – providing continuous “boosts” to their retirement pot. When they eventually die, the pot can usually be passed down IHT-free to beneficiaries.
Another strategy to consider is focusing on ISA withdrawals earlier in retirement. Savings and investments held in ISAs are not exempt from IHT upon death. This means it can sometimes make sense to consider taking income from your ISA instead of your pension to avoid IHT on death. Speak with a financial adviser for more information on this topic before making any big financial decisions.
Focus on What You Can Control
Many risks and tax rules are outside the ability of investors to control. You cannot control inflation, interest rates, or fiscal policy. However, you can choose how you navigate this landscape and maximise the potential of your portfolio with the help of professional investment advice.
For instance, investors have more power to address “unsystematic” risks rather than the aforementioned “systematic” ones. It can be impossible to predict the exact timing of an event like the pandemic, but when building a portfolio, you may look out for fund or company-specific issues like management changes, product recalls, or litigation. Any “red flags” like these may offer pause for thought.
The goal of diversification is to minimise exposure to unsystematic risk, while still retaining exposure to systematic risk. A financial adviser can help you navigate this process confidently and prudently over the long term.
Invitation
If you would like to discuss your strategy to address investment risk and taxation, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside, and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.