Tax planning is vital

While the details of tax regulations will vary from country to country, it is essential that you make use of tax regulations in your country to protect your investments going forward. There will be many different ways to protect your profits from excessive tax with countries such as the UK offering a pension fund or ISA “tax wrapper” for example. These basically allow you to buy and sell shares under a non-standard tax system whereby you may pay no tax or a reduced tax compared to traditional levels. However, why is tax planning so vital going forward?

Protecting your profits

In some countries you will have what is known as a capital gains tax allowance which basically allows you to make net profits up to a certain level per annum. Any profits above and beyond this level will attract taxation which obviously reduces your investment pool going forward. If you are able to place your investments/investment funds into a tax efficient wrapper then effectively you will either pay a reduced tax or no tax at all on your profits. This ensures that your investment pool stays as large as possible giving you more opportunity to increase the value of your portfolio going forward.

Make full use of tax allowances and tax reduction vehicles
Tax planning is vital

Accumulated profit

In order to give you an idea of the impact that tax can have on your investment portfolio let us look at a situation where for example an investor crystallises a profit of 10% per annum on a £100,000 portfolio. So, they crystallise a profit of £10,000 and let’s take a ballpark figure where they pay tax of £2000 (20 percent taxation) outside of relevant tax wrappers. This means that after year one the portfolio would be worth £108,000 once tax has been paid and after ten years, using the same annual percentage profit, it would be valued at £215,892.

If we look at the same figures under a tax wrapper, where no tax is payable, the portfolio would be worth £259,374 at the end of year 10 simply because there is additional funding each year with no tax to pay. It is also worth noting that the cash which would have been used to pay the tax, outside of the wrapper, is also increasing by 10% per annum. So, it is not difficult to see the benefits of a tax wrapper and why you should look to utilise all taxation vehicles open to you.

Working within the regulations

Time and time again government’s clampdown on tax avoidance schemes and many wealthy people have had some serious amounts of tax to pay back. The problem is that much of the taxation law around the world is written in such a way that legal experts can argue an array of different interpretations. Those who flirt on the boundaries of legal tax evasion/avoidance may well be asking for trouble in the longer term. As governments around the world continue to feel the cold wind of austerity they will be determined to retrieve as much “lost tax” as possible.

In many cases both professional and non-professional investors would do well to take advice on their taxation situation and ensure that they are making full use of all allowances and tax vehicles available to them. As we showed in the figures above, a couple of thousand pounds a year may not seem excessive but when you put the tax back in and rework the figures it does start to add up. In the example above the difference is £43,482 which is a sizeable amount by any standard!

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