Andrew Gadd puts forward the case for using VCTs as part of a retirement planning strategy
As Benjamin Franklin so rightly observed, “Nothing is certain but death and taxes” and never has this quote been more true than today.
An example of what we might expect in the future, although I suspect that this is very much the beginning rather than the end of the tightening of the purse strings, was given by Mr Darling in his April Budget. Mr Darling announced a range of tax hikes for high earners including the removal of personal allowances for those earning over £112,950 from April 2010 (based on 2009/10 personal allowances), the introduction of a 50% higher rate tax band for those with taxable income over £150,000 from April 2010 and the tapering down of pension tax breaks from 2011 so that those with an annual income over £180,000 will only receive basic rate tax relief. Legislation was also introduced with effect from 22 April 2009 aimed at preventing individuals from making ‘additional’ pension contributions prior to the new rules taking effect – the so called ‘special allowance charge’.
Ultimately all of these tax hikes have highlighted the importance of making maximum use of tax efficient investment opportunities while they are available and in certain instances perhaps thinking a little bit ‘outside the traditional box’.
Taking a different approach
One area that I suggest this applies to is pension planning and the potential use of venture capital trusts (VCTs).
There are, as we all know, a host of rules surrounding VCTs covering areas such as the type and size of companies they can invest in and the level of investment that is permitted in one company from one VCT. In simple terms, as listed companies, investors either buy newly issued VCT shares or buy them on the secondary market and as a result receive various tax benefits.
For initial offerings of ordinary VCT shares an investor currently receives income tax relief of 30% (provided they have paid sufficient tax to cover this rebate) together with exemption from income tax on dividends and exemption from capital gains tax on disposal of shares in VCTs. (For second-hand shares, the reliefs are the same apart from the fact that the initial tax relief is not available.)
All of this means that under current legislation an investor making a £20,000 investment into new shares in a VCT, assuming they have paid enough income tax, will receive tax relief of £6,000 making a net investment of £14,000. They will pay no tax on any dividends they receive and they retain the ability to sell, or indeed their investment may wind up (after five years to keep the tax incentives), without paying tax on any gains they might have made. If an investor does encash their holding or receive their investment back because the trust has wound up then the capital they receive back will be theirs to do with as they like, it is not controlled in the way that a pension pot is. It is also perhaps worth noting that there is no cap on the number of VCT shares an investor can own and investors can build up a significant holding over the years which can potentially produce a reasonable tax free income.
An attractive proposition
VCTs are attractive to income seekers, such as those in retirement, given they combine ISA-like tax benefits on dividend payments and the added ability to distribute capital gains made within the underlying portfolios, in the form of special dividends. This is distinct from income payments made on OEICs and investment trusts, for example, which simply reflect underlying yield accumulated from the portfolio.
In 2008/2009 the most popular VCT investment class were so called limited life VCTs which took approximately 50% of funds raised and these might be suitable as a first port of call for those using VCTs for pension planning – although each VCT opportunity should be carefully examined on its individual merits.
Of course VCT investments are not suitable for everybody and pension planning needs to be considered extremely carefully and appropriate investments opportunities reviewed for each client but there is I think a case for, occasionally, thinking outside the box!
Andrew Gadd is head of research at the Lighthouse Group
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