Tax Savings vs Investment Returns - Which Makes the Biggest Difference

When it comes to investing, most people focus solely on the investment selection. Whoa. Wind back. Is that a contender for most obvious statement of the year? Well yes and no. See the problem is, that the actual investment that you decide to go into is only one part of the decision.

And actually, it can even be the less important part when you’re looking at an overall investment strategy.

That’s because while picking the right place to park your money has an impact on your returns (obviously), the cut you give the government can have an even bigger effect. Yes, we’re talking about tax.

So when it comes to investing, is it better to base your decisions on the tax implications, or the potential for the underlying investment itself? 

Don’t worry, we’re going to answer just that.

The fundamental question

First off the bat, let’s answer that fundamental question. Should you consider the potential of the underlying investment or the tax wrapper around it first? Should you first find the type of account that has the best tax profile for your needs, and then select the underlying investments, or should you find the right investment and then select a tax wrapper that allows it?

Well as with anything in finance, it’s a little of Column A and a little from Column B. We know, that’s an annoying answer, but let’s break it down to give you a concrete way to look at this.

Essentially, the investment asset itself needs to stand alone. You should never invest in something that looks to be a dud, regardless of how good the tax benefits are. We’ll get into some more specifics about things like Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs) later, but sometimes they can be an example of ‘letting the tax tail wag the investment dog.’

What we mean by that, is that the tax breaks are very attractive, but the investment itself often doesn’t stack up. It’s all well and good to get 50% tax relief, but if you then lose 100% of your investment three years down the line, it’s still a horrible investment outcome.

Capital gains and income taxes are ‘success taxes.’ You pay them when you win. Yes, you want to try and minimise them in legal ways, but not if that means losing money. The investment itself needs to stand alone. 

If you find yourself being sold an investment that focuses solely or heavily on the tax benefits, you need to ask yourself why. Preferential tax treatment should be a bonus to an already attractive investment, not the main selling point.

Tax complexity vs. impact

So now we can proceed based on the understanding that there’s a baseline that an investment needs to meet in order for us to consider the tax benefits. From here, the temptation can be to wrap that underlying investment in the most complex strategy we can find.

An example that comes up semi-regularly and fits into this category is offshore bonds. Offshore bonds have some tax advantages, such as tax deferral and the ability to withdraw a certain percentage tax-free annually, but these can be offset by the potential tax liabilities that occur when funds are eventually withdrawn. 

The tax on bond withdrawals are very complex, and because of the way they’re calculated it’s possible that investors will incur a tax bill even if the underlying investment has made no gain!

We’ve all heard stories about how billionaires and their companies manage to wangle their affairs in a way that allows them to pay next to no tax.

The first problem is, it’s all relative. ‘Next to nothing’ means very different things if you’re Elon Musk or Jeff Bezos. Musk reportedly paid $11 billion in US taxes in 2021. 

Sure, that’s probably a lot less than he would have paid without proper tax planning, but the point is that you’re not likely to avoid tax altogether. And actually, the more complex you get, the more likely it is that something goes wrong or you come up against unexpected consequences.

The reality is both good news and bad news. The bad news is that there aren’t any secret special tax loopholes. The good news is that this means you can achieve pretty close to maximum tax efficiency with a fairly simple financial setup.

The tax savings pecking order

So with that in mind, let's run down the order of which accounts you should consider - from first to last.


This is an absolute no-brainer. Your cash goes into the account tax free and can be invested into a wide range of quality investment assets. There is no capital gains tax, no income tax, you can withdraw it whenever you want (tax free, obvs) and you can switch and change accounts and investments at any time you please, with no tax or penalty.

There is legitimately no reason not to max out your ISA allowance each year, unless that reason is that you physically can’t get your hands on £20,000.


Pensions have many of the same benefits as ISA’s. Money in a pension attracts no capital gains tax and no income tax. Not only that, but when you contribute into a pension from post-tax money, you receive tax relief back. That means your contribution is grossed up based on whether you’re a basic, higher or additional rate taxpayer.

So if you’re a higher rate taxpayer and you pay £8,000 into your pension, you’ll get an extra £4,000 back from the government, half directly into your pension and the other half in your own back pocket. Not too shabby.

There are a couple of downsides though. Firstly, you can’t access the money until you’re 55. Second, 25% of your pension balance can be taken tax free, but the other 75% is taxable income.

It’s for these reasons we put pensions behind ISA’s, but they’re still a great way to invest. Like an ISA it also comes with an annual limit, which is equal to your earned income or £60,000, whichever is lower.

Quick note on pensions - there are many different types. SIPP’s, for example, offer a very wide range of investment choices, and your standard workplace pension might be pretty locked down with just a few options to choose from.

Point being, not all pensions are created equal.

General Investment Account

This might be just your standard investment account, but that doesn’t mean you can’t manage your tax position within it. To begin with, investing in a diversified investment portfolio means you can buy and sell carefully to manage your gains.

This can include options like realising losses on specific investments to offset gains, timing the sale of assets across multiple tax years or transferring assets to your husband or wife prior to sale.

Not to mention the use of annual capital gains tax and dividend tax allowances, though these are admittedly becoming less and less important as the thresholds are lowered.

A final point to make on taxable accounts, is that it’s worth keeping in mind the different tax rates for income and capital gains. All things being equal, you’ll generally pay lower tax on capital gains than you would for income. 

Structuring your assets to hold income producing investments in taxable wrappers might be a strategy to consider to take advantage of this. 

Onshore and Offshore Bonds 

We’re not big fans of bonds. But we’re putting them on the list just so we can’t be accused of forgetting about them! Not to be confused with bonds as an asset class of fixed income investments, here in the UK investment bonds are also a form or life insurance product which defers tax, rather than avoid it.

The long and short of it is that onshore bonds are taxed internally at basic rate, with the balance taxable on withdrawal, while offshore bonds attract no tax, until withdrawal.

It’s a lot more complicated than this though, with the income tax calculated based on a formula that can sometimes mean tax is due even if an investment in the bond hasn’t generated any gains at all. Not only that, bonds often come at a substantially higher cost than other wrappers, and don’t benefit from any tax free allowances.


We get the appeal. Enterprise Investment Schemes and Seed Enterprise Investment Schemes offer very attractive tax benefits, and the ability to invest in early stage companies. EIS offers immediate income tax relief of 30% on investments of up to £2 million, plus the potential to avoid capital gains tax altogether on any returns made.

While EISs are for investing in small companies, SEISs are for investing in really small companies. Many of the tax benefits are the same, except you can get a whopping 50% income tax reduction.

Those tax benefits are generally a major selling point of this type of wrapper, as the underlying investments are considered to be high risk.

Even for those companies that do grow and prosper, EIS and SEIS wrappers are incredibly illiquid. Because the companies they invest in are private, it can take years to withdraw funds, if indeed it’s possible at all.


Venture capital trusts have many of the same benefits and drawbacks to EIS investments. They also receive 30% immediate tax relief, tax free dividends and no CGT on sale as long as the assets have been held for at least five years.

The main difference is that, as the name suggests, a VCT is a trust which has a fund manager making investments into a range of different companies on the investors behalf. 

Summing up

To recap, an investment needs to stand on its own. If it’s a bad investment, it doesn’t matter how good the tax benefits are, you shouldn’t make it.

With that minimum standard in place, you do need to consider where the best tax home is for those investments. But don’t make the mistake of thinking that more complexity equals greater benefits. As with many things in life, it’s the most simple, straightforward options that are likely to be the best.

As always though, just because it’s simple doesn't mean it’s easy. Getting your financial strategy and investment selection right can make a massive difference to how soon you can reach financial freedom.

Rosecut can help you with that.

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