Paul Latham discusses how venture capital trusts can help supplement clients' retirement planning
There was a highly significant announcement contained within the Chancellor's Autumn Statement that looks set to have a major impact on how people choose to save for their retirement. The government announced that from 2014 the annual allowance for pensions savings will be reduced to just £40,000.
This reduction is not only going to affect high earners, but also the self employed, workers with a final salary pension scheme, and anyone who has left it late to build a pensions pot and is trying to catch up in their later years.
Add to this list a lot of middle-income earners who have recently had a pay rise or a promotion and there is a strong chance that a number of clients could potentially find themselves with an unexpected tax bill running into thousands of pounds as a result of this one change.
No wonder then that pension savers who risk going beyond the reduced threshold are concerned. They want to keep investing for their retirement but at the same time reduce their tax liabilities, rather than adding to them.
So, I would like to suggest an alternative in the shape of venture capital trusts (VCTs). VCTs were first introduced back in 1995, allowing investors access to pooled funds comprising smaller, higher risk, companies, but doing so in a tax-efficient manner.
Indeed, VCT tax incentives (income tax relief if shares are held for five years, tax-free dividends and capital gains tax relief on the disposal of the shares) were all designed to compensate the investor for the additional risk associated with investing in smaller companies.
Since their inception, VCTs have not only a strong track record of delivering value to individual investors, but they've also delivered on their raison d'être with HM Treasury, providing a vital source of funding to UK smaller companies, particularly at a time when many small and medium-sized enterprises have found bank lending much harder to come by.
Additionally, VCT investors are often reassured by the fact that their investment is listed on the London Stock Exchange and therefore operating within a highly visible environment. All VCTs have robust safeguards in place, including an independent board of directors, and are subject to strict corporate governance and investment rules designed to protect investors.
They also have a clear investment strategy, investing in well-regulated and recognisable assets, namely trading companies. Furthermore, HMRC has strict rules in place regarding which companies qualify for inclusion within a VCT.
Of course, higher rate income tax payers currently get tax relief on any contributions they, or their employer, pay into their pension.
However, income tax is paid on the income taken from the investment at retirement. With a VCT, on the other hand, upfront income tax relief is received on the amount invested, and any income received from the VCT is also tax-free. There is no capital gains tax to pay when you decide to sell your VCT shares either.
VCTs can help reduce an investor's income tax liability, both before and after retirement. Before retirement it can be used as a long-term savings plan, with dividends reinvested to help their overall VCT savings pot to grow. What's more an investor can keep reinvesting their VCT every five years to continue to benefit from upfront income tax relief.
After retirement the VCT can provide a stream of tax-free dividends to supplement their pension income, while still preserving the capital invested.
Although initially drawn in by the tax benefits, VCT investors often choose to stay invested for other reasons. Not only do they like to follow the performance of the companies they invest in, knowing that they are benefitting financially, but they also feel good about helping UK smaller companies in general, and thereby doing their bit for the broader UK economy.
You do not get that kind of investor satisfaction with a pension.
VCTs are highly regulated investments that reward precisely those retirement-conscious investors who are prepared to save for the longer term.
So, if your clients feel frustrated by a more restrictive pensions regime, and are interested in finding alternative ways to both invest for the long term and lower their income tax liabilities, then a VCT could be the answer.
Paul Latham is a managing director at Octopus Investments
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