Why Planning Ahead Is Essential To Optimise The Best VCT

With the lifetime allowance tightening around pensions, Octopus tell us why VCTs could offer a solution for clients

Pensions have been increasingly targeted as a source of tax leakage. Recent years have seen a steady lowering of the lifetime allowance (LTA), which limits the amount that can be drawn from a pension without triggering a penal tax charge. As a result, more people have found themselves at risk of hitting their LTA.

You may well have clients who face this problem. If so, they could benefit from an alternative way to save for their retirement. One that doesn’t increase the risk of triggering their LTA and incurring extra tax charges.

For those clients comfortable with the risks, VCTs can be a tax-efficient way to continue building their retirement pot. The earlier a client starts planning for retirement, the less likely they are to find themselves constrained by the LTA.

Why more clients are facing LTA issues

When it was introduced in 2006, the LTA was set at £1.5 million. It’s now just £1.03 million. This means many more higher and additional rate tax payers are likely to fill or exceed their allowance as they approach retirement.

Indeed, the amount of tax raised by savers exceeding the LTA grew more than tenfold between 2006/07 and 2016/17.

Timely retirement planning is essential for clients at risk of hitting their LTA. The trouble is, many aren’t aware of how close they are to hitting that threshold. Clients who are at risk may not feel they are particularly wealthy, yet would still benefit from finding alternative ways to build their retirement savings.

How Sarah solved her LTA problem

Say you have a client who’s a doctor. Let’s call her Sarah.

Sarah has been contributing to her pension for more than 20 years. She has built a sizeable pension pot and she is looking forward to retirement. But now she’s worried that the value of her pension may exceed her lifetime allowance. Should she continue contributions?

As the value of Sarah’s pension nears closer to £1 million, further contributions will incur a penal tax charge when she retires. Any amount she takes as a lump sum over her allowance is liable to be taxed at 55%. And any regular income over her allowance would be taxed at an additional 25%.

Sarah meets with her financial adviser. He reviews her attitude to risk and her investment time horizon. She’s willing to invest for more than five years, to invest in smaller UK companies, and to take on the risks involved.

So Sarah’s adviser suggests a VCT.

As a tax-efficient investment, VCTs can complement pensions and other investments as part of a diversified retirement strategy. By investing in a VCT, Sarah can continue to build her retirement pot without adding to her LTA problem. She should also be able to claim income tax relief, while any dividends and capital gains will be tax-free.

But Sarah also needs to recognise that VCTs are high risk investments and should not be used for their tax benefits alone. VCTs are inherently different from pensions and should not be thought of as comparable or alternatives for one another. If Sarah needed guaranteed income or could not tolerate loss then a VCT would not be a suitable option within her retirement plan.

Since Sarah’s circumstances allow her to take on the risks that come with venture capital, a VCT could complement her existing portfolio.

What are VCTs and how do they work?

Smaller companies need investment to help them grow. Venture capital is about supporting the best small businesses with untapped potential. VCTs seek out those companies that could become the household names of the future.

Provided your investment is held for at least five years, up to £200,000 qualifies for 30% income tax relief in the tax year the investment is made. VCT shares incur no capital gains tax when sold, and there is also the potential of taxfree dividends. This could be an attractive offer for pension investors approaching their LTA.

VCT shares incur no capital gains tax when sold, and there is also the potential of taxfree dividends. This is an attractive offer for pension investors approaching their LTA

Understanding the risks of VCTs

It is important to recognise that the value of a VCT investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the VCT maintaining its VCT-qualifying status. VCT shares are by their nature high risk – their share price may be more volatile than those listed on the London Stock Exchange, and they may be harder to sell.

Supporting the next generation of British businesses

The UK is a great environment for small, fast-growing businesses, and these firms are important to the economy. High-growth small businesses – a category that includes many companies backed by VCTs – make up less than 1% of UK firms, but create as many as 3,000 new jobs every week.

VCTs play a key role providing early stage companies with the finance and expertise they need to succeed. Between 1995 and 2014, the average VCT-backed company has achieved turnover growth of 183% since initial investment. At the same time, they offer investors an opportunity to access this growth within a wider portfolio of investments.

VCTs are growing in popularity

VCTs are in high demand. £728 million was invested into VCTs in the 2017/18 tax year, an increase of 34% on the previous year.

Start planning early to make it more likely your client can invest in their preferred VCT. It also makes sense to start talking to providers sooner rather than later, so you know what’s available

They are powerful planning tools, so investors will be using them for a variety of reasons. But it’s a safe bet that many will be using VCTs within a retirement strategy, as the LTA has made pensions less attractive from a tax-perspective.

Taking the next step

If you have clients at risk of hitting their LTA, it makes sense to consider a VCT. Note that VCTs have finite fundraising capacity, and the most popular ones can fill up quickly.

Start your planning early to make it more likely your client can invest in their preferred VCT. It also makes sense to start talking to providers sooner rather than later, so you know what’s available.

Octopus has a wealth of information you can draw on, including a client-friendly guide to VCTs that explains the asset class in more depth. If you have any clients you think could benefit from investing in a VCT, you can speak to an Octopus business development manager by calling 0800 316 2967.

Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. We record telephone calls. Issued: September 2018. CAM07411-1809


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