VCT conveyor belt – a new string to your retirement bow

With the freezing of the pension lifetime allowance at £1,073,100 until 2026, a lot more individuals in their 40’s & 50’s could find themselves exceeding the allowance through investment growth alone, let alone maximising pension contributions.

The result: a tax charge of up to 55% on the excess. This is a daunting prospect, and in my view an unseemly reward for those who have worked hard and saved diligently into their pensions over their working lives.

Whilst pensions, alongside ISAs, still remain an integral part of retirement planning, it may be suitable to add a new string to your bow when planning for retirement – Venture Capital Trusts, more commonly referred to as VCTs.

Don’t let the tax tail wag the investment dog

First and foremost, a Venture Capital Trust (VCT) is an investment vehicle. Yes, they come with some interesting tax planning opportunities but as the old adage goes; never let the tax tail wag the investment dog!

VCTs were introduced in 1995 as a means of encouraging investment into small UK businesses, in need of capital to grow and expand. By investing in smaller companies your investment has the potential to access innovation and faster growth. In fact, over the past 25 years, some VCT funded companies have become household names in their own right whilst others have had very successful exits.

However, as with any investment, there contains an element of risk and, in fact, because you are investing in small, sometimes unlisted companies, VCTs should be considered high-risk and long-term investments. Furthermore, not all VCTs are the same with the option of Generalist VCTs, AIM VCTs and Specialist VCTs. This means, it is vital you look beyond just the tax planning angles and put the investment approach itself under the microscope.

But what about the tax incentives?

As an incentive for providing your capital to smaller UK companies, you are entitled to claim a number of incentives on investments of up to £200,000 each tax year. These include:

• Income tax relief of 30% on the amount you invest, provided you keep your VCT shares for at least 5 years. For example, if you invest £50,000 in a VCT you can claim £15,000 off your income tax bill for the year*.
• On disposal of your VCT shares, you will not be liable to capital gains tax on any growth.
• If your VCT pays dividends in the future, there is no tax to pay.

* Income tax relief cannot exceed the amount of income tax due.

It goes without saying that everyone’s circumstances are different and whilst VCTs won’t be suitable for all due to their higher risk nature, the attractive tax benefits mean that VCTs could be considered as part of a wider retirement portfolio alongside an individual’s pension and ISA.

It’s not the size of the hook, it’s how you wiggle your worm!

As with any tool, the real benefit comes from how you use it. You could simply invest into your VCT, claim 30% income tax relief and hopefully benefit from tax-free dividends in the future, or you could get a bit creative!

In order to keep the tax relief claimed, VCT shares must be held for at least 5 years (otherwise you must repay the tax relief to HMRC). However, after 5 years you can sell your shares with no capital gains tax liability.

Using the example below, in Years 1 to 5 you invest £50,000 each year and claim £15,000 income tax relief. After 5 years, you sell your first VCT investment and reinvest the same £50,000 capital to reduce your year 6 income tax bill.

You then repeat the process using Year 2 to fund Year 7, Year 3 to fund Year 8, so on and so forth.

Let’s take a look at the example below:

By repeating the process over 10 years, you will have claimed £150,000 in income tax relief from a VCT portfolio of £250,000 – that’s 60% tax relief on the capital invested, thus highlighting how VCT’s can provide an additional string to your bow when planning for retirement.

Warning note:

This example is for illustration purposes only as it assumes no loss or gain on any of the investments.

Some VCT shares may be difficult to sell quickly as there is less of an active market than in bigger listed companies.

You should always seek professional advice before making a VCT investment.