The financial landscape has changed drastically in the last year, for both clients and advisers.
Cash savings are now offering rates of up to 5%, which makes it harder for advisers to provide value that warrants an advice fee. And with the new Consumer Duty, the value of advice is more important than ever.
For better-than-cash returns after the impact of advice fees, investors may need to target 8% or more annually, but this also means taking on more risk.
How can advisers cope with this challenge?
Advisers may be considering higher-risk investments for a larger proportion of their clients. The enhanced level of research required to recommend these investments certainly justifies the time taken to consider and advise on them.
It’s with this backdrop that Venture Capital Trusts (VCTs) warrant special attention this year.
Tax relief and high growth potential
VCTs are listed companies that back a range of pioneering, early-stage businesses. They foster innovation in the UK by providing long-term capital to smaller, unquoted, and AIM-listed companies. These types of companies can face challenges, and some may not survive, so VCTs offer attractive tax reliefs to compensate investors for some of the risk involved.
Provided shares are held for at least five years, VCT investors can claim 30% upfront income tax relief on up to the first £200,000 invested each tax year. And VCTs typically target a 5% yield paid out as tax free dividends each year. If the performance of the VCT is very successful, it may also pay special dividends, and any incremental growth is free from capital gains tax.
When compared to a 5% VCT dividend, a non-tax efficient investment would need to pay around an 8% annual dividend to generate an equivalent post tax income for investors. If the benefit of initial income tax relief is also factored in, a non-tax efficient investment would need to pay around an 18% annual dividend to create an equivalent post tax outcome. This assumes the benefit of income tax relief is spread across the five-year minimum holding period.
We’ve shown how this looks for an additional rate tax
*Assuming dividend allowance used elsewhere
|Non-tax efficient investment
|30% income tax relief spread over five-year minimum VCT holding period
|5% target VCT dividend paid
|Dividend needed to deliver equivalent annual outcome – 18.1%
|Dividend Tax for an additional rate taxpayer (39.35%)*
|Annual outcome after tax
The example assumes no loss or gain on initial investments and does not factor any initial or exit charges. Returns and tax reliefs are not guaranteed. VCT investment is likely to have a higher-risk profile compared to a mainstream, non-tax efficient investment fund. A non-tax efficient investment can be held within an ISA, in which case it would benefit from tax free dividends. However, annual ISA contributions are limited to £20,000 a year.
The significance of tax reliefs
VCTs make an attractive income planning tool due to the combination of upfront tax relief and tax-free dividends. Investors can access higher levels of post-tax target returns associated with higher risk investing, while benefitting from the available tax reliefs.
It also provides the opportunity to advise on both tax planning and early-stage investments – a typically underserved sector, where our research shows investors have unmet appetite. Among 200 UK financial advisers, just 17% thought their clients were interested in investing in early-stage companies, and yet, when roughly 1,000 UK adults with investments partly or fully managed by an adviser were asked the same question, 45% expressed interest1.
Understanding the risks
The generous tax reliefs for VCTs are provided as some compensation to investors willing to accept the additional risks that come with a high-risk investment.
The value of VCT shares, and income generated, can fall as well as rise. Investors may not get back the full amount they invest. Given the exposure to early-stage companies, the value of VCT shares can be volatile and they may be hard to sell.
Tax treatment depends on individual circumstances and may change in the future. Tax reliefs also depend on the VCT maintaining its qualifying status. Investors must be comfortable holding shares for five years or longer to keep any income tax relief they claim.
Because natural demand for VCT shares on the secondary market is limited, VCTs usually offer a share buyback facility for investors, provided there are funds available. These are typically conducted at a 5% discount to Net Asset Value and are completed at the board’s discretion.
Help clients reach their goals and grow your business
VCTs are a very accessible investment, with minimum investment sizes starting at around £3,000. The average investment value is around £25,000, and once familiar, there is a high propensity for investors to revisit VCT investments every year as part of their annual tax and investment planning. As a result, VCTs can form a valuable part of an adviser’s business.
Advisers also tend to find that VCTs are useful for a much broader range of clients than they initially thought.
So while cases sizes can be of a smaller size, the cumulative impact for your business could be significant.
With the current environment being challenging for advisers to add value, now is a great opportunity to consider VCTs and integrate them into your offering as a unique selling point. Doing so could support you in delivering good outcomes for your clients and business.
1Opinium Research, survey of 1020 UK Adults with investments partly/fully managed by an adviser and 206 UK IFAs, April 2023