Read on to find out about investments and how much tax you might need to pay.
Most of us are familiar with paying Income Tax on our earnings from employment. But you may also have to pay tax on investment gains or income, depending on how you receive them, and how much you have earned. The amount of investment tax you pay also depends on your overall income from salary and other sources.
That depends on your personal circumstances. If you earn a lot of interest or dividends from savings and shares, or if you pay higher rate tax, then you may have to pay tax on your investments. However, there are lots of tax-efficient savings products which can shield your investments from tax and enable it to grow in a tax-free way.
There are two main types of tax you might have to pay on your investments.
Income Tax The first one is Income Tax, and this includes tax on interest received on savings, and any money received from share dividends.
Capital Gain Tax The second type of tax is called Capital Gain Tax, and you may be liable to pay this when you come to sell an asset. In other words, investments made for capital growth have tax implications because these gains (also known as profits) may be subject to Capital Gains Tax (CGT).
Not all investment income is taxed at the same rate; there are specific rules, entitlements and tax-free allowances that you need to be aware of if you are planning to invest.
There are also a number of investment options that are tax-free, offering a tax-efficient way of investing.
Here's a list of investment income that is liable for tax:
Interest from most savings
Income from a pension
Dividends from shares
Capital gain from the sale of shares or property
There are a number of tax-free allowances, which every adult in the UK is entitled to.
These allowances have been set up by the government to encourage people to save and invest, to drive growth or to increase the supply in the market. Two important allowances are the Personal Savings Allowance and the Dividend Allowance. Both are affected by how much Income Tax you are liable to pay, and which tax bracket you fall into.
How does my investment income affect my tax rate?
You're allowed to earn a certain amount of money tax-free, known as your tax-free allowance. Beyond this threshold you will start to pay tax. In the 2022 to 2023 tax year the tax-free allowance for each adult is £12,570. This is also known as the Personal Allowance. The higher rate threshold – the point at which you have to pay tax at the higher rate – is £50,270 for the tax year 2021 to 2022.
Income Tax rates
You pay 20% basic rate tax for any income between your personal allowance and £50,270
You pay 40% higher rate tax for any income above £50,271
For income between £100,000 and £125,000 you also lose your personal allowance. It goes down by £1 for every £2 you earn, meaning most of your earnings goes to the taxman.
You pay 45% additional rate tax for any income above £150,000
Income tax is progressive, the higher your income the more tax you pay.
If an investment gives you an income, rather than capital growth, then the Income Tax rules apply.
So drawing your pension (through an annuity or other similar product) will be taxed at your rate of Income Tax. Rental income from 'residential' property letting - the profit from your rental property after allowable deductions - will also be taxed in this way.
The Personal Savings Allowance (PSA) is the amount of money you can earn in interest from savings accounts, before you have to pay tax on it. In the 2022 to 2023 tax year this allowance is £1,000 if you're a basic rate taxpayer.
In other words, you can earn up to £1,000 on your savings before you have to pay any tax. For most people, this is quite a large allowance because interest rates are currently low, and the amount of interest paid by banks and building societies is low.
For higher rate tax payers, the allowance falls to just £500 a year, and for those people who pay additional rate tax, the PSA falls to zero.
The Dividend Allowance is the amount of dividends you can earn from stocks and shares in any one tax year before you have to pay any additional tax. In the 2022 to 2023 tax year the Dividend Allowance for each adult individual is £2,000.
A dividend is a part of the company's profits that is given to shareholders - the dividend is calculated per share, so the more shares you own, the more money you get.
Dividends attract Income Tax if you earn more than £2,000 of dividends within a single tax year. If your dividend income exceeds the annual Dividend Allowance, then you pay tax at the following rates on any income above this threshold in the 2021 to 2022 tax year:
If you're a basic rate taxpayer, you pay tax at 7.5%
If you're a higher rate taxpayer, you pay tax at 32.5%
If you're an additional rate taxpayer, you pay tax at 38.1%
An exception to these tax rules is any income from savings or dividends that are generated within an Individual Savings Account (ISA). This includes ISAs which were previously PEPs under the old rules. All income, dividends and gains made within an ISA is tax-free, which makes them an ideal savings vehicle if you want to reduce your potential tax bill.
When you sell an asset – property, shares or other items of value – and you make a profit on it, then you are said to have made a Capital Gain. Where you make gains above a certain level you may have to pay tax on these profits.
The Capital Gains Tax Allowance is the amount of profit you are allowed to make in a single tax year without having to pay tax. The Capital Gains Tax Allowance (CGT) for the 2022 to 2023 tax year is £12,300, the same as it was the previous tax year.
If you dispose of an asset for more money than you bought it for, you're said to have made a capital gain, or in more familiar terms, a profit.
There are a number of assets that aren't subject to Capital Gains Tax. For example, you don't pay any CGT when you sell your main home, irrespective of the profit made. Capital Gains Tax may apply to the sale of property/assets bought as an investment, and to the disposal of some stocks and shares.
If you have sold some shares at a loss during the tax year, you can offset this loss against any gains you may have made.
The way you pay tax on your investment income depends on your tax band and on the type of investment in question.
In the case of Capital Gains Tax, this is only be payable once your tax return has been submitted and your tax liability has been calculated by your tax adviser or HM Revenue & Customs (HMRC).
It's important to make provision for your tax bill when you receive money from investments.
Children also get a Personal Savings Allowance of £1,000 per tax year.
If investments are held in a Child Trust Fund (CTF) or Junior ISA (JISA) then there's no additional tax to pay. Like ordinary adult ISAs, all investments and savings within a Junior ISA or Child Trust Fund grow free of income tax or capital gains tax.
When you're making a decision about where to invest your money, you need to factor in the tax implications of each product, based on your personal circumstances, in order to make a judgement about what returns you're likely to make.
Tax levels are reviewed annually. You can check the most up-to-date tax information from HM Revenue & Customs or speak with a qualified tax adviser.