Don't dodge tax only to walk into losses

High earners will soon be feeling poorer. On 6 April, the highest marginal rate of income tax rises to 50% for those with incomes over £150,000. And anyone earning between £100,000 and £112,950 will suffer an effective rate of up to 60% as the personal allowance (which allows you to earn your first £6,475 tax free) is whittled away at a rate of £1 for every £2 earned above £100,000. So many advisers are now touting ways to protect your wealth from the taxman. We look at the main ones below. But watch out. The tax breaks may look good but they come with some big risks.

1. Converting income to capital gains

"Converting income into capital gains has become the holy grail of tax planning," says Liz Coleman in The Times. That's because capital gains tax (CGT) is levied at a flat rate of 18% across the board. So assets that are subject mainly to CGT look more attractive than those which generate lots of income. Examples include currencies (so if you deposit, say, e100,000 in an account, and sterling then weakens against the euro, you'll make a tax-free gain on conversion back into sterling) or investment property.

But piling into these to cut your tax bill isn't a good idea. Sure, if you spend a lot of time overseas or regularly buy and sell overseas assets, then a foreign currency account can cut transaction costs. But as this week's events show, currencies are very volatile buying into them simply on the basis of a tax break would be ridiculous. As for property, MoneyWeek's view is that UK property prices are heading for another long decline. So again, any tax benefits are offset by the risk of losing your original capital.

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2. Offshore bonds

Offshore bonds investment bonds run by life assurance firms are a favourite with some advisers. The selling point is that income tax is only paid on them when the bond is cashed in. So you could benefit if you're a higher-rate taxpayer now, but expect to be a lower-rate payer by the time you cash it in (if you plan to retire, say).

But these bonds are fraught with pitfalls. In fact, Charles MacKinnon, head of Thurleigh Investment Managers, describes them as "toxic waste" in the Financial Times. For a start, fees can be high 1.5% a year for an adviser is not uncommon. And the choice of underlying investment can be restricted. That's partly why so many performed poorly last year, prompting Aviva the UK's biggest insurer to pull out of the market altogether. And as Lee Smythe at Killik warns, predicting the tax rate you'll pay in, say, ten years' time is tricky. Get it wrong and you might end up with a big income tax bill when the bond is cashed. And who's to say a cash-strapped future government won't change the rules?

3. VCTs and EISs

Another option touted to higher-rate taxpayers is to invest in a venture capital trust (VCT) or an enterprise investment scheme (EIS). Both offer big tax breaks mainly on income tax. A VCT investor gets 30% relief on up to £200,000 a year provided the investment is held for at least five years. Dividends are tax-free and there is no CGT on any profits.

On an EIS, the maximum income tax relief is given at a rate of 20% and, should the scheme pay a dividend (many don't), it's taxable. But an EIS comes with a big kicker subject to certain criteria, CGT arising on any disposal can be rolled into an EIS (you buy one with your sales proceeds) and deferred indefinitely. And an EIS also falls outside of your 'death estate' for inheritance tax purposes.

Sounds great. And if you pick the right scheme, says John Blowers of EIS specialist Pre-X, your money might "double, treble or quadruple over a three- to five-year timescale". But "many fail". That's because VCTs and EISs invest in start-ups and small, fast-growing businesses, so they are very risky you don't get those sorts of tax breaks for nothing. Many aren't cheap either. For example, Oxford Capital's latest offering focusing on start-ups from Britain's science parks and universities levies an initial fee of 5%, an annual fee of 2.5% and a performance fee of 20%.

4. Zeros

Zero-dividend shares (or zeros) look a better bet at first. These pay no income hence the name. Instead, like bonds, they are redeemed at face value at a set future date. So any profit comes in the form of a capital gain, which is then taxed at 18% (after using your CGT allowance, which is currently £10,100). The shares are typically issued by split-capital investment trusts. Around a decade ago, a number of these collapsed they were careless with borrowed money leaving investors out of pocket. Zeros had also been mis-sold as low-risk, so the reputation of investment trusts in general took a hammering, and there have been few split-cap launches in recent years.

And now the trouble is that recent demand, partly driven by the tax changes, has driven prices up. Tim Whiting of Timothy James & Partners likes zeros from Jupiter's Second Split fund, for example. These aim to return 40.5p each to holders when redeemed in October 2014. They now trade at about 30p, so that gives you an equivalent annual return of about 6.2% between now and then. Or there's the Ecofin Water & Power Opportunities offering 5.9% a year to 2016.

But if you're prepared to lock your cash up for that long, you can get 4.6% a year with a Leeds Building Society five-year fixed-rate Isa. That's 1.6% below the Jupiter zero but it's risk-free. If you want to avoid tax but don't want to risk your money, that's as good as you'll get.