Top ten tips: Beat the taxman at his own game

Pensions are among the most tax-efficient savings vehicles, giving tax relief at your highest marginal rate. A monthly £1,000 contribution costs a basic-rate taxpayer just £800. If you received average returns of 7.5 per cent a year after costs, you’d have a pot of £2.03 million after 35 years from a contribution of £420,000. Higher-rate taxpayers gain further relief of another £200 a month through the self-assessment system. You can save up to £50,000 of earnings a year into pensions. You can take up to 25 per cent of your pension fund as a tax-free lump sum after you turn 55.

2. Cash Isas

You can save up to £5,340 of your £10,680 annual allowance in a tax-free cash individual savings account (Isa). Many accounts offer instant access, making this an ideal home for your emergency fund. Interest rates at present are not fantastic, but you can get up to about 3 per cent.

3. Premium bonds

Run by government-backed NS&I, premium bonds are a means of saving whereby, instead of receiving interest, you are entered into a monthly prize draw where you can win between £25 and £1m tax-free. The prize pot is determined by an interest rate, currently 1.5 per cent. The tax-free status means this equates to 1.875 per cent for a basic-rate taxpayer, 2.5 per cent for a higher-rate taxpayer and 3 per cent for a 50 per cent taxpayer. However, there is no guarantee of winning, and the value of your capital could quickly be eroded by inflation.

4. Children’s bonds

NS&I withdrew its inflation-linked savings bonds at the start of September following excessive demand, but it still offers children’s bonus bonds, again with tax-free returns. Issue 34 pays 2.5 per cent.

5. Equity Isas

You can invest your full Isa allowance, equivalent to £890 a month, into an equity Isa. The government has pledged to increase the annual limit in line with the retail prices index (RPI) inflation measure. If this averages 3.5 per cent a year and you get net investment returns of 7.5 per cent, in 25 years’ time, you’d have more than £1m having only contributed £430,000 – tax free.

6. Onshore bonds

Investment bonds are designed to produce medium to long-term capital growth. You can normally withdraw up to 5 per cent of the original investment each year without any immediate income tax liability. These bonds also include some life cover.

7. Offshore bonds

The main tax benefit of investing in an offshore bond is “gross roll-up”. This means that any underlying investment gains are not subject to tax at source (apart from an element of withholding tax). This means an offshore investment has the potential to grow faster than one in a taxed fund.

8. Qualifying savings plans

These regular savings vehicles are designed to run for a fixed term. They can invest in a range of collective investment funds, from bonds and property to UK and overseas shares. The main benefit is that investment returns are taxed at the rate applicable to life insurance companies, rather than the investor’s own personal tax rate.

9. Enterprise investment scheme

EISs offer 30 per cent upfront income tax relief, if held for three years. You can invest up to £500,000 a year, a figure that will double to £1m at the start of the 2012-13 tax year. Capital gains can be deferred by reinvesting gains into an EIS. Gains on disposal are completely exempt from capital gains tax after three years. Losses on EIS investments can be set against chargeable gains or offset against income, though a deduction is made for initial income tax relief. If EIS shares are held for two years they attract full inheritance tax relief.

10. Venture capital trusts

Income tax relief of 30 per cent is given on VCTs. The maximum investment is £200,000 a year and the minimum holding period five years. Dividends are exempt from income tax. Capital gains are tax free, but you can’t defer gains or offset losses with VCTs. Remember that both EISs and VCTs are high-risk investments.