PThe increased focus on pension contribution limits have brought venture capital trusts (VCTs) further into the advice spectrum, says Paul Latham, Octopus Investments.
Advice firms are increasingly turning to venture capital trusts (VCTs) particularly as tightening limits on pension contributions have meant more clients need an alternative way to invest tax efficiently.
It has made VCTs a more mainstream solution and a mainstay of many advice firms’ offering. Today, it’s not uncommon for advisers to have as many as 20 high earning clients investing in a VCT every tax year.
High earners can’t rely on their pension alone
There are two ways a client is limited with pension contributions. One is the annual allowance, the other is the lifetime allowance.
Once you’ve exceeded those allowances, pensions become a less efficient way to invest for retirement.
The annual allowance for the 2020-21 tax year is £40,000. For those with an adjusted income over £150,000, their allowance will be even less, tapering by £1 for every £2 over this. That means some high earners will have an annual allowance of just £10,000.
There’s also the lifetime allowance (LTA) to consider. It’s a limit on the tax privileged pension funds you can build up for retirement. It was once as high as £1.8 million, but now sits at just £1.03 million.
When a client exceeds the LTA, any further contributions can incur an additional tax charge, the rate of which depends on whether the excess is withdrawn as a lump sum, where it is taxed at 55%, or as income, where it is taxed at 25% (tax is then payable on the income received at marginal rates).
Considering these hefty tax charges, it’s no surprise that more clients are looking for alternative tax-efficient ways to plan for retirement and are turning to VCTs.
How VCTs can solve the pension problem
The government introduced VCTs in 1995 to incentivise investment into higher risk, early-stage companies by giving investors attractive tax reliefs in return.
For the right client, a VCT could be a powerful alternative when their pension is no longer tax efficient.
- Upfront tax relief — clients can claim 30% income tax relief on investments up to £200,000 in a tax year, provided they are held for at least five years.
- Tax-free income and growth — dividends and capital growth from a VCT investment are tax-free. This is why VCTs have become an interesting option when looking to supplement income in retirement as part of a portfolio.
- Diversification – VCTs can be a great way to diversify across smaller companies given that they invest largely in unquoted and AIM listed companies. They can also be a way to access new share offers that you wouldn’t otherwise be able to.
Bear in mind the risks
Of course, just because a high earning client has been affected by changes to pension legislation doesn’t mean that a VCT investment will be the right option for them.
VCTs are considered high risk investments. The value of a VCT investment, and any income from it, can fall as well as rise and clients may not get back the full amount they invest.
Tax treatment always depends on individual circumstances and may change in the future. Tax reliefs also depend on the VCT maintaining its qualifying status.
Clients considering a VCT will also need to be comfortable that the share prices can be volatile and they may be harder to sell than other listed shares.
VCTs are a growing part of advice businesses
The pension problem isn’t going anywhere. Clients who reach their life-time allowance could benefits from alternative solutions to their pension and ISAs if they want to plan effectively for retirement.
If the advisers you’re working with aren’t currently writing VCT business, chances are they will be in the future. And those that are already doing VCTs will no doubt see their popularity increase. It makes sense then to know this type of investment inside out.