How To Build Wealth Without Paying Any Tax

People discussing building wealth or investing often discuss the latest top stock pick or crypto trend. How to approach investing to minimise the tax burden is rarely discussed.

Now we are not talking here about tax evasion. That is avoiding paying legitimate tax when it is due. We are talking about legitimately arranging your financial affairs to minimise tax and are used by the rich to arrange their tax affairs legally.

There are five reasons why most people should look to do this:

• Reason #1: It reduces the amount you need to pay in tax each year
• Reason #2: Although potentially small amounts, this can compound over time to make a significant difference
• Reason #3: It can make as big a difference as which stocks/funds/bonds you choose
• Reason #4: If you adopt this strategy and automate it builds wealth at a faster rate as you sleep
• Reason #5: If arranged correctly, you can reduce your inheritance tax burden when passing wealth on to your family in the future.

Want to know more? Then read on…..

Where should I invest my money?

In simple terms, your money is put into an account or investment vehicle such as a pension, ISA, unit trust etc. These are termed wrappers and have different tax advantages. So which wrapper should I use, and in what order?

When looking at your financial plan, you should look to put money in these wrappers or, as I like to call them, buckets. The main buckets you can use are as follows :

Pension

Putting money into a pension is hands down the most tax-efficient investment method. In the UK (provided you have already paid income tax), the money you put in a pension automatically gets a 20% uplift. So £300 invested automatically becomes £375.

If you are a higher rate taxpayer (Income >£50K or an additional rate taxpayer>£150k), you can also claim back 20-25% in your tax return. This represents a significant uplift before your investment even starts and, compounded over the long term, makes a significant difference.

The amount you can put into a pension annually stands at £40k but is increasing to £60K in the 2023-2024 tax year.

In addition to that, money accrued inside of a pension can be handed on to your family members after death outside of your estate for inheritance tax purposes.

The main downside of investing in a pension is gaining access to it before you reach retirement age, which will likely be 57, depending on your current age.

If you are investing for the long term, planning for money in retirement or think you will not need this in retirement, this is by far the most tax-efficient way of investing your money and should be the first bucket you fill.

ISA

An ISA should normally be the second bucket you look to fill. You pay no tax on putting money or taking money out of this. Whilst it does not have the tax uplift of a pension, when investment increases, being able to draw a tax-free income and lump sums can be a very useful income source.

Although it does sit outside your estate for IHT purposes, you can put £20K in cash or investments annually.

The main advantage of an ISA is that it is relatively liquid, meaning you can get your cash out if needed. Whilst it is not recommended, this is possible if the worst were to happen. It can also be useful if using an ISA to buy something specific in the medium term e.g. saving for a house deposit in fiver years.

Let’s look at an example of saving for retirement:

If you started saving £250 per month every year between 30 and 60, with 7% growth in your investment, your amount aged 60 would be £304,992. This could lead to a tax-free income annual of £21.3K (assuming ongoing 7% growth) and the ability to take lump sums as needed.

If this was in a normal saving account with the same growth and getting taxed at 40%, the growth would be nearer 4% rather than 7%. Over the same 30-60 period would give £173,512 and an annual retirement income of £6.9K.

This is the power of understanding tax efficiency and investing correctly over time.

These two wrappers should allow the vast majority of investors to save up to £80K in a very tax-efficient way and a method for increasing liquidity (i.e. cash available if needed) and planning for retirement.

Unit Trust

If you are lucky enough to be one of the people who can save >£80K per year, there are other ways to increase savings tax-efficiently. This method uses the annual Capital Gains Tax (CGT) Allowance.

Most people encounter CGT when selling a second property, but it also applies to selling stocks and shares.

This works by buying funds in a unit trust (usually through an adviser or financial institution) and then selling them before the end of the financial year. You then buy a different Unit Trust (must be different funds) in the New financial year. You then have a CGT allowance of £12300. So as long as your gain has not been greater than this, there is no tax to pay.

This allows you to get to £150-200K in investments, and as long as they are managed properly will be free from paying tax on the growth.

One spanner in the works with this method is that the Chancellor has indicated a reduction in the CGT allowance from £12.3K to £6k in the next financial year (2023-24)

VCT/EIS/Investment Bonds

If, despite all of this, you still have money to invest, then Venture Capital Trusts (VCTs), Enterprise Investment Schemes (EISs), and Investment Bonds are all options for improving your tax efficiency.

It is beyond the scope of this blog post, but I will do a separate post on each of these as they are slightly more complex investment vehicles.

Actionable Steps

For the vast majority of people reaching £80K per year is way beyond what they are saving, but there are some important lessons/actions you can take here:

1. Find out the details of your pension – how much is going into it? What is it projected to provide in retirement?
2. Could you increase the amount going into this? For example, try increasing this by 10%, then do the same every six months.
3. If you don’t have a pension – start small and start now. Even a small amount regularly will benefit from the tax breaks.
4. Are you regularly putting into an ISA? If not, could you put even a small amount in? Again try to increase this by 10% every six months and see what happens.

I hope this has been useful, and I’d love to hear your perspective on this.

Good luck on your journey!