Venture capital trusts (VCTs) are powerful planning tools because of their tax reliefs. An investor might use a VCT for a variety of reasons, but they could be especially helpful when planning for retirement.
Over the last few years, pensions have been increasingly used to raise tax revenue. To make this happen, the Lifetime Allowance (LTA), which is a limit on the amount that can be drawn from a pension without incurring an extra tax charge, has been reduced significantly since its inception.
If you have clients losing out because of the tightening LTA, it pays to consider alternative ways to continue saving for retirement.
For those clients able to tolerate the risks of investing in smaller companies, VCTs can be a tax-efficient way to invest as part of a retirement strategy.
The tightening allowance
The LTA is currently £1.03 million. But when introduced, the allowance was set at £1.5 million. This might not seem like a big change, but the reality is that many more higher and additional rate tax payers are exceeding their allowance.
In fact, the tax revenue raised from those exceeding the LTA grew by more than twenty times between 2006-07 and 2016-17. The problem is that many people aren’t aware that they are at risk of exceeding their allowance. You may well have clients at risk who do not perceive themselves as particularly wealthy now, but that could benefit from other options to save for retirement.
The key is to start retirement planning early, so that clients are less likely to be constrained by the LTA.
How you could help a client by suggesting a VCT
Say you have a client called Sarah. She’s a doctor and has contributed to her pension for some time. She has built a sizeable pension pot and she is looking forward to retirement.
But Sarah is now worried that the value of her pension may exceed her Lifetime Allowance.
As the value of Sarah’s pension nears closer to £1 million, further contributions will incur an additional tax charge when she retires. The tax rate of the additional charge depends of whether the excess is paid as a lump sum, where it is taxed at 55%, or as income, where it is taxed at 25% (tax is then payable on the income received at marginal rates).
Sarah meets with her financial adviser. He looks at her attitude to risk and her investment time horizon. She’s willing to invest for more than five years and to back smaller UK companies. Crucially, she is willing and able to take on the risks involved.
So Sarah’s adviser suggests a VCT.
Before she makes any decisions, it’s important that Sarah understands the benefits and risks of VCTs.
VCTs can complement pensions and other investments as part of a diversified retirement strategy. By investing in a VCT, Sarah can build her total retirement pot without using more of her LTA. 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, could not tolerate loss, or was uncomfortable losing immediate access to her money, then a VCT or a pension would not be a suitable options for her.
Since Sarah is willing and able 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 often need investment to help them grow. Venture capital is about finding the best small businesses that have untapped potential and providing them with the capital and expertise needed to expand. 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 any single tax year. VCT shares incur no capital gains tax when sold, and there is also the potential of tax-free 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.
Backing British businesses
Smaller companies have an important role in the UK economy. High growth small businesses (HGSBs) – 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 can provide early stage companies with the finance and expertise they need to succeed. As a result, between 1995 and 2014, the average VCT-backed company 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.
Taking the next step
You may well have clients at risk of hitting their LTA. For those clients, it makes sense to consider a VCT.
It also makes sense to start talking to providers now, so you know what’s available.
Note that VCTs have finite fundraising capacity, and the most popular ones can fill up quickly. You should start your planning early to make it more likely your client can invest in their preferred VCT.
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
 Source: Centre for Economics and Business Research, 2016
 Source: AIC survey, 1995-2014
Please read: Personal opinions may change and should not be seen as advice or a recommendation. VCTs are not suitable for everyone. Any recommendation should be based on a holistic review of your client’s financial situation, objectives and needs. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. We record telephone calls. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: October 2018. CAM07543-1810