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Should I invest my tax refund?

Should I Invest My Tax Refund?

A tax refund is a return on any tax you have overpaid in the past tax year. You may receive it for a wide variety of reasons, ranging from payments from a previous employer to foreign income. According to RIFT, the average refund in the UK is around £2,500.

If you’ve suddenly received one, you may be asking yourself: should I invest my tax refund? In this article, I’ll tell you everything you need to know.

Key Takeaways

  • A tax refund is when you have paid too much tax at some point in the past. The overpayment is given back to you by HMRC.
  • There are lots of different things you can do with a tax refund; from investing it through an investment account, to saving it in a Lifetime ISA toward the deposit for a house.
  • However, you should carefully consider whether you can afford to invest it or not.
  • For example, you may want to think about using it to pay off any debts or contribute it to your emergency savings before you invest it.

Is investing your tax refund right for you?

When it comes to investing your tax refund, there are both positives and negatives involved that you should keep in mind before you make your decision.

Read on to discover the things you should think about before you decide to invest your tax refund.

Benefits of investing your tax refund

You could generate a return

Since the interest rates offered by savings accounts are currently quite low, investing is potentially a great way to grow your tax refund and generate returns.

There are a huge variety of different types of investments that offer varying degrees of risk too, so even if you are a new investor that has a low tolerance for risk, there are options out there for you.

If you are new to investing, contributing your tax refund to an investment account could be a great way to start investing. Meanwhile, even if you’re an experienced investor, a tax refund could bolster your portfolio.

You should keep in mind, however, that the value of your investments can go down as well as up. If you’re unsure how to invest your tax refund, you should contact a financial advisor or a certified financial planner.

It could help you achieve your short- and medium-term goals

Investing your tax refund could also be a great way to meet any short- or medium-term financial goals you may have.

This could be anything ranging from saving toward the holiday of your dreams to the down payment for a house. An unexpected windfall of money could be the perfect way for you to meet any of these goals you may have.

Things to think about before you invest your tax refund

You might need it for bills or debts

First and foremost, before you invest your tax refund, you should ideally make sure that you’ve paid off any outstanding bills and debts, such as credit card debt or other types of high-interest debt.

A tax refund could be a good way to become debt-free and gain some financial security, as the sudden influx of “free money” could potentially help you get ahead of the curve and take the weight of bills and debts off your shoulders.

Make a debt payoff plan if you want to be sure whether you can afford to invest your tax refund.

You may want to prioritise your emergency fund first

If the past few years have taught us anything, it’s that unexpected expenses can arise without warning. That’s why you may want to contribute your tax refund to your emergency fund before you think about investing it.

You should ideally keep somewhere between three to nine months’ worth of essential expenses saved away for a rainy day.

This money should also be saved in easy-access savings accounts so you can access it at any time; after all, you never know when a financial emergency will arise.

Some financial peace of mind goes a long way in keeping you stress-free, so creating a savings plan and contributing your tax refund toward your emergency savings may be a great way to start saving for any eventuality, such as unforeseen medical expenses or car repairs.

3 clever ways to use your tax refund

If you don’t have any outstanding bills or debts, and your emergency fund is full, you may want to think about investing your tax refund and potentially watching it grow.

Continue reading to discover three clever ways to invest your tax refund.

1. Investing it in the stock market may offer decent returns

If you like the idea of investing your tax refund in the stock market and potentially watching it grow, then there are various different assets for you to consider. This includes:

Two types of investing accounts you could use to invest in these assets are a General Investment Account or a Stocks and Shares ISA.

Different providers offer various benefits on these accounts, so make sure you read my guide on the best investment apps to find out more about what these providers can offer.

General Investment Account (GIA)

GIAs are a type of investment account that allow you to invest your money without limits.

You can invest as much money as you’d like in many different assets, meaning you’ll be able to invest your entire tax refund through your account.

However, you will need to bear tax in mind when investing through a GIA.

Typically, you’ll be subject to Capital Gains Tax (CGT) on any profits from investments above your annual CGT exempt amount. This allowance is £12,300 in the 2022/23 tax year.

Once you reach this allowance, you’ll typically pay 10% CGT (18% for property that isn’t your main residence) if you’re a basic-rate taxpayer, and 20% (28% for property that isn’t your main residence) if you’re a higher- or additional-rate taxpayer.

You’ll also potentially face Dividend Tax with a GIA. You do have a Dividend Allowance before Dividend Tax is due, which is £2,000 in the 2022/23 tax year. However, any dividends you receive above this amount will be taxed within the same year you earn them.

As of April 2022, Dividend Tax is:

  • 8.75% for basic-rate taxpayers
  • 33.75% for higher-rate taxpayers
  • 39.35% for additional-rate taxpayers.

So, while there are no contribution limits with a GIA, they aren’t particularly tax-efficient.

Stocks and Shares ISA

A Stocks and Shares ISA may provide a more tax-efficient way to invest your tax refund.

Like a GIA, a Stocks and Shares ISA allows you to invest in a variety of different investment options.

The beauty of a Stocks and Shares ISA is its tax efficiency – you will be entirely protected from Income Tax and CGT on any returns your investments generate. However, you should keep in mind that your Stocks and Shares ISA is not tax-free as you may still be subject to Inheritance Tax (IHT).

The tax-efficient nature of a Stocks and Shares ISA is countered by the fact that your deposits are limited by your overall ISA allowance, which stands at £20,000 as of 2022/23.

So, if you’re lucky enough to have a tax refund that’s greater than this amount, you may need to spread it across accounts.

2. Saving it in a Lifetime ISA (LISA) could be a good way to save the deposit for a home

If you are planning on purchasing a home in the foreseeable future or want to make a head start on your retirement savings, then a LISA may be the perfect way to start saving.

A Lifetime ISA is available to anyone between the ages of 18 and 39. With a LISA, you can save or invest up to £4,000 each tax year and the government will offer an extra 25% bonus on contributions.

This means that if you invest the maximum amount of £4,000 in a year, you will gain an extra £1,000 in government bonuses each year. This £4,000 does count towards your overall ISA allowance (£20,000 in 2022/23).

You can save your money in a Cash LISA or invest it in the stock market through a Stocks and Shares LISA.

As is the case with other types of ISA, a LISA is protected from CGT and Income Tax. You should keep in mind, however, that if you try to withdraw your money for anything other than the deposit for a house, or before you reach the age of 60, you will typically face a 25% withdrawal fee.

If your tax refund is more than £4,000, you may want to think about spreading it out between a LISA and a Stocks and Shares ISA. This way, you can take full advantage of the government bonus, while still being able to invest your entire tax refund.

3. Contributing it towards your retirement could give you some peace of mind for your future self

You may not have given any thought to contributing money to a pension. In fact, if you are younger, this may be the last thing on your mind.

But, using your tax refund to build retirement funds in a pension can be a good way to start securing your financial future for when you retire.

Of course, you should only do this if you don’t need your money right now. That’s because, typically, you won’t be able to access your pension until age 55 (rising to 57 in 2028).

Pensions are highly tax-efficient in two ways. Firstly, any money invested is protected from Income Tax and CGT. Your pension will also typically fall outside the value of your estate, meaning it may be free from IHT.

Additionally, any contributions you make will qualify for tax relief at your marginal rate of Income Tax. That means a £100 contribution only “costs” you £80 if you pay basic-rate Income Tax. For higher- and additional-rate taxpayers, this falls to £60 and £55 respectively.

This tax relief is only applied up to the pension Annual Allowance. In the 2022/23 tax year, this is up to £40,000 or 100% of your earnings, whichever is lower. Either way, this will likely be a high enough threshold for any money you receive on a tax refund.

Two types of pension you might want to consider are a self-invested personal pension, or a stakeholder pension.

Read our comprehensive guide on pensions if you want a more in-depth look at the benefits of a pension, and the different providers out there.

Self-invested personal pension (SIPP)

A SIPP is a type of pension that gives you a great deal of control over how your money is invested. They typically offer a much wider variety of choices when it comes to investing, including:

  • Shares in companies of your choice
  • Investment trusts
  • Funds or exchange-traded funds (ETFs)
  • Property.

Anyone below the age of 75 can open a SIPP and start saving toward their retirement.

You should keep in mind that the value of investments can rise as well as fall, so you could end up losing money. If you aren’t as confident making your own investment decisions, you can always seek advice from a financial advisor.

Stakeholder pensions

Stakeholder pensions give you less flexibility when it comes to choosing how your money is invested, though they do come with their own set of benefits.

While your choice of investments is more limited, stakeholder pensions tend to offer lower-risk investment options, potentially making them better for more inexperienced investors.

Unlike SIPPs, they also tend not to charge you for stopping contributions into your pension or for transferring to another plan. This could make them ideal for those with inconsistent streams of income, or if you plan on just paying into it with your tax refund and no more afterwards.

These low-risk investment options come with a downside, however, as lower risk may come with lower reward. So, they may be better as a method to slowly build a pension pot, rather than for trying to make big gains through investments.

Should I invest my tax return FAQs

What exactly is a tax refund?

If you pay taxes and end up paying too much, you should receive a tax refund from HMRC. This could be for several reasons, including:

• Pay from a previous job
• Pension payments
• Redundancy payments
• Foreign income
• A miscalculation on your tax return.

Should I invest my tax refund or save it?

You could invest your tax refund if you want to try and achieve returns on it. However, you must also be comfortable with the potential of losing the money you invest.

Meanwhile, you could save your tax refund in a high-yield savings account if you’d rather keep your money in cash. You can, of course, use tax refunds to pay off any high-interest debt, such as credit card debt.

 

Please note

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial needs.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts. 

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