VCTs: the new pension for higher earners?

Whilst pensions have become tainted in the eyes of many after never-ending government reforms, they have probably been the best and most tax-efficient way over time to save for retirement. Up until earlier in this decade, some high earners could invest £255,000 per tax year in a pension and get a significant percentage of that back in tax relief.  

Those days are gone.

Since the years immediately following the financial crisis, the tax benefits pensions offer have gradually been eroded by successive governments eager to collect more tax.

Rule changes make it very difficult to build a decent retirement fund

From 6 April 2016, many high earners will only be able to contribute £10,000 per tax year to their pension. In addition, because of the lifetime allowance being reduced by 20% to £1million, many will be unable to make any contributions at all. 

These restrictions along with miserly gilt rates mean getting a decent investment income from many products designed for retirement is almost impossible.

So what options are there for those who want to invest tax efficiently but have already used up their pension allowances?

The answer in my view could be one that is surprisingly under-publicised. Venture capital trusts, or VCTs as they’re commonly known.

The similarities to pensions are there: upfront tax relief and tax-free growth. However, you currently receive two added bonuses:

  1. With VCTs, your annual allowance is much more generous – £200,000.  When you invest you also receive up to 30% income tax relief, so your effective cost could be as little as £140,000. 
  2. You get tax-free dividends. So to receive £1,000 in your hand from a VCT, you only need a £1,000 dividend as there is no tax and it doesn't even need to be listed on the annual tax return. Compare this to a "normal" investment. As an additional-rate taxpayer you would need a cheque for £1,444 to receive £1,000 in your pocket after tax (under current pre-April 5 2016 rules).

As with any other dividends, the manager aims to deliver a certain yield, typically around 5%, but cannot guarantee this will be achieved.

If you don't want income now, and you are planning for your future retirement then many VCTs offer a dividend reinvestment scheme. The shares bought within the scheme will count towards your annual VCT investment allowance and qualify for the 30% upfront tax relief. Therefore if you make large contributions you need to ensure this doesn’t take you over the £200,000 limit.

A big difference between pensions and VCTs is in where they are invested. A pension such as a SIPP is generally invested in shares and bonds of large companies, in the UK and overseas. VCTs instead invest in very small UK companies so they are considerably riskier. Please read the Risks and Commitments to find out why these products are not suitable for everyone. 

Please remember that should you be in any doubt about the suitability of these investments or your pension provision then you should obtain professional financial advice.

That said for those who are limited by the new much lower annual pension allowance or who may have hit the lifetime allowance, VCTs could be an interesting addition for more sophisticated investors as part of a balanced portfolio.

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