Tax-efficient fund investing: making the most of ISAs and SIPPs in 2025

Mutual funds remain the go-to investment choice for many investors. Their simplicity, diversification, and professional management have made them a long-time favourite for those building long-term wealth. But it takes more than just choosing the right fund to be a great investor. The way you invest in mutual funds can make a big difference to your returns too.

Tax-efficient investing involves two key decisions: choosing the right investment account and selecting the right investments. Tax-advantaged wrappers like Individual Savings Accounts (ISAs) and Self-Invested Personal Pensions (SIPPs), help shield your gains from tax, building you a portfolio that works harder for your long-term goals.

Part 1 – What are tax-efficient accounts?

If you're investing with tax efficiencies in mind, then you're aiming to minimise the tax you pay to grow your investments. Remember though, these tax-advantaged accounts have contribution limits.

And if you’ve already reached your annual contribution limits for ISAs or pensions, investment selection becomes even more important for tax planning.

ISA allowance

You can contribute up to £20,000 per tax year across all adult ISAs (including Cash ISA, Stocks & Shares ISA, Innovative Finance ISA, and Lifetime ISA). You can open a stocks and shares ISA with Freetrade for as little as £0/month.

Pension allowance

For the 2025/26 tax year, the standard annual allowance for pension contributions (including contributions into a SIPP and any workplace pension) is £60,000 or 100% of your taxable earnings, whichever is lower. 

High earners may face a tapered allowance, and any unused pension allowance from the previous three tax years can be carried forward, subject to rules and eligibility. With Freetrade, your SIPP is included with the Plus plan for just £11.99 per month (or £9.99/month when paid annually). 

What are capital gains?

Capital gains are a big reason both ISAs and SIPPs are so popular. Whenever you sell an investment for more than you paid, you generate a capital gain. You get an annual allowance of £3,000 for the 2025/26 tax year, but above that, if your investments are not in an ISA or SIPP then you may owe tax.

Your Capital Gains Tax (CGT) rate depends on your tax-bracket.

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Always ensure your investment decisions are up to date with HMRC rules and that they maintain adherence to tax laws to avoid penalties.

ISA vs SIPP for tax-efficient investing 

A Stocks and Shares ISA is ideal for flexible, tax-free growth. While you should be prepared to have your money invested for at least five years in order to weather the ebbs and flows of the stock market, you can withdraw funds from an ISA at any time with no tax consequences. This makes it perfect for medium-term goals like home deposits, early retirement or simply growing your wealth.

A SIPP is better suited for long-term retirement planning as it offers tax relief on contributions. For instance, an £800 deposit becomes £1,000 if you're a basic rate taxpayer. This boost means you could theoretically invest the same amount in an ISA and SIPP, but end up with a bigger initial pot in the latter. Your investments grow tax-free, and withdrawals start from age 55 (rising to 57 in 2028).

While contributions to your ISA are after tax (and therefore you don’t get a boost), when it comes time to draw a regular income from your SIPP outside of the 25% tax-free lump sum, you’ll pay tax on these.  

What’s most important is that you start investing as soon as you can. According to Bowmore Asset Management, those who delay investing until the end of the tax year (rather than starting at the beginning of each tax year) could miss out on over £130,000 in returns over a lifetime. So, focus on taking that first step rather than the perfect step, because you don't need to choose between the two accounts, and both can have a vital part to play in your tax-efficient investing strategy. 

Part 2 – How are mutual funds taxed?

While tax-efficient accounts shield your investments from tax, your choice of investment within these accounts matters too. 

In the UK, Exchange Traded Funds (ETFs), unit trusts and Open-Ended Investment Companies (OEICs) (both types of mutual funds) are exempt from capital gains tax at the fund level. 

This means that as an investor, you’ll typically only generate a tax bill when receiving dividends or other income from the fund, or when selling your investment. If your investment is housed within tax-efficient wrapper, like an ISA or SIPP, you will not even generate this tax bill.

What are mutual funds?

Mutual funds pool money from investors to create a professionally managed portfolio. These portfolios may include stocks and shares, bonds, or other assets, depending on the fund’s goal.

They are ideal for long-term investors who want exposure to stock markets without having to pick out individual stocks. Many are actively managed, with fund managers selecting investments they believe will outperform the market.

What are ETFs?

ETFs are generally passively managed and have low turnover, which can make them more tax-efficient in taxable accounts if they distribute income less frequently. ETFs offer cost-effective diversification and are a popular choice among DIY investors seeking lower fees. However, they may lack the active management that can make mutual funds attractive for many long-term investors.

Are ETFs or mutual funds more tax-efficient?

For UK investors there isn’t a clear cut answer. It will always depend on the types of income that fund managers pay to investors as both mutual funds and ETFs are capital gains exempt at the fund level and don’t distribute these tax liabilities to investors like in the US. 

But inside an ISA or SIPP, this difference disappears. 

FAQs on tax-efficient investing in the UK

What is the best tax-free investment in the UK?

There’s no one-size-fits-all answer, but the most effective tax-free strategy is to start early within ISAs or SIPPs, and choose diversified products that match your goals. Mutual funds and ETFs can both work well when tax-wrapped, allowing your investments to grow free from tax and benefit fully from compounding. The exact timing of your investments won’t make or break your portfolio, but investing earlier in the tax year can significantly improve returns, especially in tax-advantaged accounts.

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Important information