Last week saw the big US banks announce bumper profits. Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo announced a total of $142 billion of profits in 2024 – up 20% year-on-year.
That was driven by a surge in deal making worldwide, which not only bodes well for bankers bonuses, but for all the lawyers, accountants and consultants that grease the wheels of corporate deal making.
Nicholas Hyett, Investment Manager at Wealth Club said, “High finance is famous for its bumper bonuses. But in the UK, more and more of the City’s bonus bonanza is likely to end up in the hands of the taxman.
Frozen tax thresholds and tapered pension allowances are steadily ratcheting up the tax burden on higher earners – and with very little financial headroom to play with, the government is unlikely to change course any time soon. Making the most of a bonus requires careful consideration of the investment options that remain – but could save tens of thousands in tax.
Below we’ve set out how a higher rate taxpayer could potentially invest a £100,000 bonus, while cutting their tax bill by around £30,000 or even more.”
Investing a £100,000 bonus
Invest up to £60,000 bonus in a pension
Most employers offer a ‘salary sacrifice’ option, despite the somewhat off-putting name, it simply allows you to send part, or all of your bonus straight to your pension. Not only could you save income tax (45 per cent, if you are a top-rate taxpayer), but you could also save National Insurance.
“Pensions should be the first port of call for any investor, whatever the size of the bonus. In fact, they are arguably, and perhaps controversially, more valuable to higher earners – since tax relief is provided at the marginal rate.
Most people can put as much as they earn into a pension, capped at £60,000 a year. However, the very highest earners see their allowance taper away, with those earning more than £260,000 limited to investing £10,000 a year.
The previous pensions cap called the lifetime allowance (LTA) was removed last year so there is no cap on the value of the pension you can build, though in practice investors may want to think twice before building a massive pension. When you retire, you can take up to 25% tax free or £268,275 (whichever is lower) tax free, whilst the rest is taxed like income.”
Invest up to £20,000 in an ISA
Once you have ticked off the pension, using your full £20,000 ISA allowance is the next natural step. You don’t get tax benefits on the way in, but you do on the way out – no tax on income or withdrawals – plus any growth is tax free.
“ISAs have the advantage of being accessible, whereas pension savings are locked away for years or even decades. The £20,000 allowance has been unchanged since 2017/18 – and while valuable, is just a starting point for higher earners.
Those with children might want to consider Junior ISAs – allowing you to shelter up to £9,000 a year on behalf of your children.”
Invest £20,000 to £70,000 into early-stage businesses through venture capital
Once your ISA and pension are done, the next best thing – and an increasingly popular choice amongst experienced investors – are the government-backed venture capital schemes: venture capital trusts (VCTs), the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
“The various venture capital schemes are among the few tax reliefs that have escaped recent tax raising efforts unscathed. That’s because the young businesses these schemes support are seen as crucial to driving economic growth and the creation of high value jobs for the future.
For investors, the schemes are not only highly tax efficient, but could also add something different to a more conventional investment portfolio. Venture Capital Trusts (VCTs), Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) provide exposure to young, ambitious and fast-growing companies – some of which may become tomorrow’s household names – and receive income tax relief of up to 50 per cent (as well as various other tax benefits).
These are riskier and more illiquid than mainstream investments and therefore only for experienced investors. But that’s why the government offers such generous tax reliefs. As with any investment, it also helps if you spread your money over different investments.”
Venture Capital Trusts (VCTs)
With VCTs, you invest in a listed company which, in turn, invests in young fast-growing businesses chosen by a fund manager. So, a single investment can give you exposure to a portfolio of 50-100 businesses.
“VCTs are stock market listed funds, not unlike investment trusts, that invest specifically in young, usually private businesses looking to fund growth. They offer exposure to a well diversified portfolio of companies, and thanks to their stock market listing are relatively easy to sell. That makes them a common first port of call for investors with a large tax bill who have already maxed out their pension and ISA allowances.
You can invest up to £200,000 in VCTs each tax year and get up to 30 per cent income tax relief. Most returns come through dividends which are tax free, as is any growth. To keep the tax relief, you must hold a VCT for at least five years.”
Enterprise Investment Scheme (EIS)
With EIS, you invest directly in young and ambitious companies that you choose yourself or that a fund manager chooses on your behalf. Typically, an EIS fund will give you exposure to 5-15 companies, so it’s more concentrated – and hence higher risk – than a VCT. But in recognition of this, the tax reliefs are more generous.
“EIS companies are not dissimilar to the companies backed by VCTs. However, in order to qualify for EIS relief you must invest directly in the company itself. This means EIS investments are usually more concentrated and less liquid – making them riskier.
However, that additional risk is offset to some degree by significantly higher tax reliefs. Investors receive income tax relief of up to 30 per cent. In addition, any growth is tax free; you can also defer taxable gains you might have made elsewhere and the resulting CGT bill; and the investment can qualify for IHT relief if you hold it for two years and on death.
Lastly, if you lose money on your EIS investment, you can write the loss off against your tax bill in the year you make the loss. So if a £10,000 investment resulted in a total loss, once you take into account all the tax reliefs, the most a 45 per cent taxpayer could lose is £3,850. To keep the tax relief you must hold an EIS investment for at least three years.
Investors can invest up to £1m a year in EIS qualifying investments – £2m if those companies qualify as knowledge intensive. This scope makes EIS particularly popular with the very highest earners.”
Seed Enterprise Investment Scheme (SEIS)
SEIS is designed to provide the first capital to help young and ambitious companies get off the ground. You can choose the companies yourself or let a fund manager choose on your behalf. Typically, an SEIS fund will give you exposure to 10-30 start ups.
“SEIS backs the very youngest businesses in the UK, often little more than an idea. That makes SEIS the riskiest of the three venture capital schemes, but it comes with correspondingly generous reliefs. Potential for capital gains tax (CGT) relief is particularly distinctive though less relevant for those worried about paying tax on a bonus.
You can invest up to £200,000 each year, and receive income tax relief of up to 50%. In addition, any growth is tax free; you can also receive up to 50% CGT relief on taxable gains you might have made elsewhere; and the investment can qualify for IHT relief if you hold it for at least two years and on death.
If you lose money on your SEIS investment, you can write the loss off against your tax bill in the year you make the loss. So if a £10,000 investment resulted in a total loss, once you take into account all the tax reliefs, the most a 45% taxpayer could lose is £1,550. To keep the tax relief you must hold an SEIS investment for at least three years.”
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