Guy Myles, co-founder of Octopus Investments, argues that advisers have a vital role to play in helping investors choose the most appropriate tax wrappers at this time of year
The end of the tax year is almost upon us and, sure enough, the personal finance press are full of articles about the various tax-efficient investments we should all be snapping up before the 5 April deadline. Top up your pensions, the message goes, max out your ISA, take full advantage of Venture Capital Trusts (VCTs) and don’t forget an Enterprise Investment Scheme (EIS). That way you can save as much tax as possible.
Don’t get me wrong. I’m all for making sure people don’t pay any more tax than they need to. And it’s great that this year’s Budget means we will be able to save even more tax on pensions and ISAs. However, the thinking behind many of these articles seems to be that the tax savings are their most important consideration. Some articles lump the various tax wrappers together in the same bucket and attempt to compare the tax savings on each one – as if that was what investors should be concentrating on.
In the real world, however, that should not be how people will be making investment decisions in the last few weeks of the 2013/14 tax year. First of all, it’s just not practical to compare the tax benefits of these various wrappers – how can you weigh up the tax-free dividends from an ISA against the loss relief on an EIS? You’d just be comparing apples and Mexican dragon fruit.
Much more important is the fact that each of these products works in a very different way. They have their own characteristics and offer different approaches to risk and return considerations. That means they are suitable for very different investment needs – they are not just alternative ways of saving tax.
The bedrock of financial planning
For the vast majority of people, pension and ISA investments should still be the top priority. Pensions address the basic need of providing for our old age and will soon offer extra options for the way we take income from them, while ISAs offer more flexibility for medium-term savings. These potted definitions may be stating the obvious, but they’re a useful reminder of why these tax wrappers should be at the heart of financial planning for just about every UK citizen who has any money to put aside for the future.
Most people don’t need – or, more likely, won’t have enough disposable cash for – investments beyond these. And they are better sticking to pensions and ISAs, rather than trying to spread their investments into VCTs and EIS as well, especially now that they won’t have to buy an annuity with their pension pot. On the other hand, there are significant numbers of people who need to consider other options beyond pensions and ISAs.
The most obvious reason investors might come into this category is that they have a high income, or assets that they need to invest. These are people who can comfortably invest the full allowance in their ISAs each year and are now having to contend with reductions in the amount they can save in a pension. They’re not necessarily wealthy (or ‘high-net-worth’ as we say nowadays). Headteachers, doctors, senior executives are all in danger of exceeding the reduced lifetime allowance. Even their standard work pension scheme could exceed the new £1.25 million limit after 30 or 40 years’ growth. And they have to face a significant risk of the allowance coming down even further in years to come. For these people having all their eggs in the pension basket could be a mistake.
The Pensions Challenge
In spite of the changes George Osborne announced last week, there is still a lot of uncertainty about the future tax regime around pensions. The annual allowance for tax-free pension contributions has come down from £50,000 to £40,000 and Labour is talking about cutting tax relief on pensions for high earners if it wins next year’s general election.
For anyone affected by these changes, VCTs can offer a more attractive option than simply building up an investment account outside any tax wrappers. VCTs won’t be an alternative to pension schemes, but they’ll complement them, offering more flexibility and the potential for tax-free growth and dividends. VCTs are a maturing market. In recent years they have become much more mainstream – many funds have built up a strong record of returns, and there is an expanding range of investment strategies, including regular tax-free income as well as out-and-out growth.
An EIS will suit different needs again. The investment limits are higher, £1 million a year, compared with £200,000 for a VCT, but that doesn’t mean they are just a step-up in terms of how wealthy the investor is. An EIS can cater for a more complex range of needs – sheltering capital gains from tax, for example, and inheritance tax planning.
Keep it smart
I work for the UK’s leading VCT and EIS provider, but even I wouldn’t pretend these products have a place in everyone’s portfolio. And I would never want any of our customers to choose a VCT or EIS before they put money in a pension or ISA, or simply on the basis of how much tax they could save. I’m sure that in the last few weeks of the tax year, advisers will be encouraging their clients to be discriminating about the tax wrappers they choose and helping them to look for the smartest way to address their specific needs.