Do Investments Count as Income?

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Investment income is the money you earn from your savings or investments, such as interest, dividends, or capital gains. It can be a significant source of income for many people, especially those who have large portfolios or rely on passive income streams.

However, investment income is not always tax-free. Depending on the type and amount of investment income you receive, you may have to pay tax on it at different rates and under different rules. This can affect your overall income and tax liability, as well as your financial goals and plans.

Therefore, it is important to know if your investments count as income and how they are taxed in the UK. In this article, we will explain how investment income is taxed, how you can reduce tax on investment income, and what you need to consider when investing for tax purposes.

Key Takeaway

Type of Investment Income Tax Rate Tax-Free Allowance
Interest 0%, 20%, 40% or 45% Personal Allowance (£12,570), Starting Rate for Savings (£5,000), Personal Savings Allowance (£1,000 or £500)
Dividends 8.75%, 33.75% or 39.35% Personal Allowance (£12,570), Dividend Allowance (£2,000)
Capital Gains 10%, 20%, or 28% Personal Allowance (£12,570), Annual Exempt Amount (£12,300)
  • You can reduce tax on investment income by using tax reliefs, offsetting losses, donating to charities, and choosing tax-efficient investments.
  • You should be aware of the risks and limitations of these strategies, such as market volatility, transaction costs, eligibility criteria, and reporting requirements.
  • You should seek professional advice if you are unsure about your tax situation or need help with tax planning.

How Investment Income is Taxed in the UK

The amount of tax you pay on your investment income depends on the type of income you receive and your total income for the tax year. The tax year runs from 6 April to 5 April the following year.

Interest

Interest is the money you receive from lending your money to others, such as banks, building societies, peer-to-peer platforms, or bond issuers. Interest is usually paid at a fixed or variable rate over a period of time.

Interest is taxed at your marginal rate of Income Tax, which is the highest rate of tax you pay on your income. The current Income Tax rates in the UK are:

Band Taxable Income Tax Rate
Personal Allowance Up to £12,570 0%
Basic Rate £12,571 to £50,270 20%
Higher Rate £50,271 to £150,000 40%
Additional Rate Over £150,000 45%

However, you may not have to pay any tax on your interest income if it falls within your tax-free allowances. These include:

  • Your Personal Allowance: This is the amount of income you can earn before you pay any Income Tax. For most people, it is £12,570 for the 2021/22 tax year. However, it may be higher or lower depending on your circumstances.
  • Your Starting Rate for Savings: This is an additional amount of interest income you can earn without paying any Income Tax if your other income (such as wages or pensions) is below a certain threshold. For most people, it is £5,000 for the 2021/22 tax year. However, it may be lower or zero depending on your other income.
  • Your Personal Savings Allowance: This is a further amount of interest income you can earn without paying any Income Tax if your total income is below a certain threshold. For most people, it is £1,000 for basic rate taxpayers and £500 for higher rate taxpayers for the 2021/22 tax year. However, it may be lower or zero depending on your total income.

To work out how much tax you pay on your interest income, you need to add up all your interest income from different sources and subtract your tax-free allowances. The remaining amount is your taxable interest income, which is taxed at your marginal rate of Income Tax.

For example, suppose you earn £20,000 from your salary and £3,000 from interest in the 2021/22 tax year. Your tax calculation would be:

Income Amount Tax Rate Tax Due
Salary £20,000 0% on the first £12,570, 20% on the next £7,430 £0 + £1,486 = £1,486
Interest £3,000 0% on the first £2,000 (£12,570 – £10,570), 0% on the next £5,000 (Starting Rate for Savings), 0% on the next £1,000 (Personal Savings Allowance), 20% on the remaining £0 £0 + £0 + £0 + £0 = £0
Total £23,000 – £1,486

As you can see, you do not have to pay any tax on your interest income because it is covered by your tax-free allowances. However, if your interest income was higher or your other income was lower, you may have to pay some tax on it.

Dividends

Dividends are the money you receive from owning shares in a company or a fund that invests in shares. Dividends are usually paid as a percentage of the company’s profits or the fund’s returns.

Dividends are taxed at a different rate than interest or other income. The current dividend tax rates in the UK are:

Band Taxable Income Tax Rate
Personal Allowance Up to £12,570 0%
Basic Rate £12,571 to £50,270 8.75%
Higher Rate £50,271 to £150,000 33.75%
Additional Rate Over £150,000 39.35%

However, you may not have to pay any tax on your dividend income if it falls within your tax-free allowances. These include:

  • Your Personal Allowance: This is the same as for interest income.
  • Your Dividend Allowance: This is an additional amount of dividend income you can earn without paying any dividend tax. For everyone, it is £2,000 for the 2021/22 tax year.

To work out how much tax you pay on your dividend income, you need to add up all your dividend income from different sources and subtract your tax-free allowances. The remaining amount is your taxable dividend income, which is taxed at your marginal rate of dividend tax.

For example, suppose you earn £40,000 from your salary and £4,000 from dividends in the 2021/22 tax year. Your tax calculation would be:

Income Amount Tax Rate Tax Due
Salary £40,000 0% on the first £12,570, 20% on the next £27,430 £0 + £5,486 = £5,486
Dividends £4,000 0% on the first £2,000 (Dividend Allowance), 8.75% on the next £2,000 (Basic Rate) £0 + £175 = £175
Total £44,000 – £5,661

As you can see, you have to pay some tax on your dividend income because it exceeds your Dividend Allowance. However, if your dividend income was lower or your other income was higher, you may have to pay more or less tax on it.

Capital Gains

Capital gains are the profits you make when you sell or dispose of an asset that has increased in value since you acquired it. Examples of assets that can generate capital gains include shares, funds, property (except your main home), jewellery, art, antiques and collectibles.

Capital gains are taxed at a different rate than interest or dividends. The current capital gains tax rates in the UK are:

Asset Type Basic Rate Taxpayer Higher or Additional Rate Taxpayer
Property (except main home) 18% 28%
Other Assets (e.g. shares) 10% 20%

However, you may not have

to pay any tax on your capital gains if they fall within your tax-free allowances. These include:

  • Your Personal Allowance: This is the same as for interest and dividend income.
  • Your Annual Exempt Amount: This is an additional amount of capital gains you can make without paying any capital gains tax. For most people, it is £12,300 for the 2021/22 tax year. However, it may be lower or higher depending on your circumstances.

To work out how much tax you pay on your capital gains, you need to add up all your capital gains from different assets and subtract your tax-free allowances. The remaining amount is your taxable capital gains, which are taxed at the appropriate rate depending on the type of asset and your income tax band.

For example, suppose you sell some shares and a property (not your main home) in the 2021/22 tax year and make a total capital gain of £20,000. You also earn £50,000 from your salary and £2,000 from dividends. Your tax calculation would be:

Income Amount Tax Rate Tax Due
Salary £50,000 0% on the first £12,570, 20% on the next £37,430 £0 + £7,486 = £7,486
Dividends £2,000 0% on the first £2,000 (Dividend Allowance), 8.75% on the remaining £0 (Basic Rate) £0 + £0 = £0
Capital Gains £20,000 0% on the first £12,570 (Personal Allowance), 10% on the next £9,730 (£50,270 – £40,540) (Basic Rate for shares), 20% on the remaining £1,300 (£20,000 – £18,700) (Higher Rate for shares), 28% on the remaining £0 (£20,000 – £20,000) (Higher Rate for property) £0 + £973 + £260 + £0 = £1,233
Total £72,000 – £8,719

As you can see, you have to pay some tax on your capital gains because they exceed your tax-free allowances. However, if your capital gains were lower or your other income were higher, you may have to pay more or less tax on them.

Tax-Exempt or Tax-Efficient Investments

Some investments are exempt from tax or have special tax rules that make them more efficient than others. These include:

  • Individual Savings Accounts (ISAs): These are accounts that allow you to save or invest up to a certain amount each year without paying any tax on the interest, dividends or capital gains you earn. For the 2021/22 tax year, the ISA allowance is £20,000 per person. There are different types of ISAs available, such as cash ISAs, stocks and shares ISAs, innovative finance ISAs and lifetime ISAs.
  • Pensions: These are schemes that allow you to save for your retirement and receive tax relief on your contributions. The amount of tax relief you get depends on your income tax band and the type of pension scheme you have. For the 2021/22 tax year, the annual allowance for pension contributions is £40,000 per person or 100% of your earnings, whichever is lower. There are also lifetime and tapered allowances that limit the total amount you can save in pensions over your lifetime.
  • Premium Bonds: These are bonds issued by the government that do not pay any interest but enter you into a monthly prize draw where you can win up to £1 million. The prizes are tax-free and you can invest up to £50,000 per person in premium bonds.
  • Venture Capital Trusts (VCTs): These are funds that invest in small and risky businesses that are not listed on the stock market. You can receive up to 30% income tax relief on your investments in VCTs up to a maximum of £200,000 per year. You also do not pay any tax on the dividends or capital gains you receive from VCTs.
  • Enterprise Investment Scheme (EIS): This is a scheme that allows you to invest in small and risky businesses that are not listed on the stock market. You can receive up to 30% income tax relief on your investments in EIS up to a maximum of £1 million per year. You also do not pay any capital gains tax on the profits you make from EIS if you hold them for at least three years. You can also defer paying capital gains tax on other assets if you reinvest them in EIS within a certain time frame.
  • Seed Enterprise Investment Scheme (SEIS): This is a scheme that allows you to invest in very small and risky businesses that are not listed on the stock market. You can receive up to 50% income tax relief on your investments in SEIS up to a maximum of £100,000 per year. You also do not pay any capital gains tax on the profits you make from SEIS if you hold them for at least three years. You can also exempt up to 50% of your capital gains from other assets if you reinvest them in SEIS within a certain time frame.

These investments can help you reduce your tax bill and increase your returns, but they also come with some risks and limitations. For example, they may be illiquid, volatile, complex, or subject to changes in tax rules. Therefore, you should only invest in them if you understand the risks and can afford to lose your money.

How to Reduce Tax on Investment Income

Apart from choosing tax-exempt or tax-efficient investments, there are some other strategies you can use to lower your taxable income and reduce your tax bill. These include:

  • Using tax reliefs: There are some tax reliefs available for certain types of investment income or expenses, such as interest paid on loans to invest in businesses or property, or fees paid to financial advisers or brokers. You can claim these reliefs on your tax return and reduce your taxable income by the amount of relief you are entitled to.
  • Offsetting losses: If you make a loss on an investment, you can use it to reduce your taxable gains from other investments in the same or future tax years. You can also carry forward unused losses indefinitely until you have enough gains to offset them. However, you can only offset losses from the same type of income, such as capital losses against capital gains or interest losses against interest income.
  • Donating to charities: If you donate money or assets to a registered charity, you can claim tax relief on your donation and reduce your taxable income by the amount of your donation. You can also avoid paying capital gains tax on any assets you donate that have increased in value since you acquired them.
  • Choosing tax-efficient investments: Some investments are more tax-efficient than others because they have lower tax rates, higher allowances, or special rules that favour them. For example, investing in shares may be more tax-efficient than investing in bonds because shares have lower dividend tax rates and higher dividend allowances than bonds have interest tax rates and allowances. Similarly, investing in UK property may be more tax-efficient than investing in foreign property because UK property is subject to lower capital gains tax rates and higher annual exempt amounts than foreign property.

These strategies can help you save money on your tax bill and increase your net returns, but they also have some drawbacks and challenges. For example, they may involve additional costs, risks, complexity, or reporting requirements. Therefore, you should only use them if they suit your personal circumstances and financial goals.

Conclusion

Investment income is the money you earn from your savings or investments, such as interest, dividends, or capital gains. It can be a significant source of income for many people, but it is not always tax-free.

Depending on the type and amount of investment income you receive, you may have to pay tax on it at different rates and under different rules. This can affect your overall income and tax liability, as well as your financial goals and plans.

Therefore, it is important to know if your investments count as income and how they are taxed in the UK. By understanding and planning for tax on investment income, you can optimize your investment strategy and maximize your returns.

However, tax on investment income can be complex and confusing, especially if you have multiple sources of income or invest in different types of assets. Therefore, you should seek professional advice if you are unsure about your tax situation or need help with tax planning.

 

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