WE’VE EMPHASISED THE importance of keeping your costs to a minimum and, at risk of boring you, here’s another reminder:
The less you pay to invest, the more money you keep for yourself.
It really is that simple.
But there’s one cost of investing that people tend to overlook, and that’s tax.
If you’re a UK citizen and you make a profit when you sell shares or other assets such as Bitcoin, you may have to pay Capital Gains Tax. You will need to make a note of any gains you make, declare them on your tax return and pay any tax owing.
The good news is that, if you’re smart about it, you shouldn’t need to pay any tax at all, regardless of the size of the gains you make. Better still, savvy investors actually enlist the help of HMRC and get the taxman to make substantial contributions to their long-term investments.
The best investment strategies are usually the simplest. So, our suggestion is that you confine your savings and investments to as few accounts as possible.
Do bear in mind that the rules regarding tax on savings and investments are subject to change, so be sure to check the latest information. But, at the time of publication, your best option for your emergency fund is a Cash ISA. Using an ISA, any interest you earn will be tax-free.
Once your emergency fund is in place, you need to be investing in equities, which have of course delivered far higher returns historically than cash.
As things stand at the time of going to print, the best starting point for young investors is a Lifetime ISA, or LISA. As long as you didn’t turn 40 on or before 6 April 2017, you are eligible to have one.
Here’s the deal. For every £4 you invest, the government will add £1 – a benefit worth up to £1,000 every tax year until you turn 50. This 25% bonus is payable on the first £4,000 you invest and it’s paid every month.
The only catch with a LISA is that if you take any money out before the age of 60 and spend it on anything other than your first house, you’ll be hit with a 25% penalty when you withdraw your cash. In other words, the government wants to incentivise you to invest for the long term which, as we’ve explained, it is in your interests to do.
But, if you do want the flexibility to take your money out and spend it on what you want, you should invest in a third type of ISA, known as a Stocks and Shares ISA, alongside your Cash ISA and LISA.
Regardless of how many ISAs you have, the maximum you’re able to invest in any one year is £20,000.
If you like the idea of the taxman contributing to your savings and investments, we haven’t told you the half of it. That’s because the government is even more generous when it comes to pensions. There are even more generous tax incentives on offer here.
When paying into your pension, you receive tax relief on any contributions that you make. This is at the highest rate of income tax that you pay, provided that the total gross pension contributions you make do not exceed your annual earnings or what’s called the annual allowance, which is capped at £40,000.
In other words, if you’re a 20% taxpayer, the taxman puts in an extra 20 pence for every pound you invest. If you pay tax at 40%, the government contributes 40 pence for every pound.
For your pension investing, you can either choose to make additional contributions to your workplace pension, or set up a personal pension and contribute to that. You will get the tax relief in either case.
Think about it. Why risk your money on a trading platform, when you can invest, via your pension, in index funds that spread your risk between every stock on a particular market – and when the government will chip in with an extra 20% or 40% of tax relief.
So, why share a chunk of your investment returns with HMRC when you don’t actually need to? Instead of paying the taxman, get the taxman to pay you. Invest as much as you reasonably can in a combination of ISAs, plus a workplace pension or personal pension.
With all of this saving and investing that we are recommending, when, realistically, will you become financially independent? We’ll take a look at that in the next chapter.