In recent years, pension savers have faced a number of changes in the tax landscape. On the one hand, most people now have a lot more flexibility and control over their pension savings since the 2015 Pension Freedoms, which allows you to start drawing from your workplace and/or private pension(s) from the age of 55. You are also no longer required to use your pension savings to buy an annuity, but now have other options available such as the likes of a ‘drawdown’ arrangement.
On the other hand, pension savers also arguably face new restrictions in respect of tax reliefs. For instance, in 2006-07, it was possible to commit up to £215,000 for the tax year into pension savings. Today in 2019-20, the Annual Allowance is significantly lower at £40,000, or up to your yearly salary – whichever is higher.
This, coupled with the ISA savings limit of £20,000 per year, is causing many higher earners, in particular, to question whether there are other tax-efficient avenues open to them to save for the longer term and retirement. For those in this position, there is fortunately a range of options available.
In this article, we’ll be taking a look at three in particular: Venture Capital Trusts, Enterprise Investment Schemes and Seed Enterprise Investment Schemes.
Below, you will find a brief overview of each one and a short summary of some of their respective pros and cons. Please note that this content is for information purposes only and should not be taken as financial advice. To receive tailored, regulated financial advice about your own situation please speak to one of our Financial Planners.
Venture Capital Trusts (VCTs) can be a compelling option for those clients with a higher risk appetite who are interested in investing in small businesses and who want to take advantage of some attractive tax reliefs.
A VCT is a company which typically trades on the London Stock Exchange (LSE), and its main purpose is to achieve growth and income by investing in a portfolio of unquoted businesses. The businesses are selected by the fund manager or team, who will be experienced in finding strong positions for the portfolio.
One powerful reason to consider a VCT is the 30% Income Tax relief which you can claim on the value of your investment. Two important conditions are that you can only invest up to £200,000 per year into VCTs, and you must hold shares for 5 years to retain the tax relief.
So, suppose you invest £10,000 of capital into a VCT, you would receive Tax Relief of £3,000 (i.e. 30%) assuming you hold the investment for the qualifying period, and pay this much Income Tax in the Tax Year in question.
There are drawbacks, however, which you need to be aware of. First of all, there are fees which you will need to pay for the management of the VCTs. These can be around 2%-3% per year, and this naturally eats into your investment returns. Secondly, you will need to factor the 5 years holding period into your financial plan, which might not work for everyone.
The Enterprise Investment Scheme (EIS) is often confused with VCTs, as they can sound very similar. However, there are some important differences – not least being that the former is a Government Scheme, whilst the latter are quoted companies.
Similar to VCTs, investing in EIS-qualifying companies allows you to claim back 30% of your investment as Income Tax relief. However, one significant difference is the treatment of dividends. VCTs allow you to generate an income via tax-free dividends, which can make them an attractive supplementary tax-free retirement income source.
One of the crucial advantages of EIS investments is that they are exempt from Inheritance Tax, provided the investments qualify for Business Property Relief (BPR) and provided you have owned them for at least 2 years. In addition, whilst you can only commit up to £200,000 per tax year into a VCT, you can put up to £1m per year into EIS-qualifying companies. Indeed, you can even commit up to £2m provided the EIS companies qualify as “knowledge intensive”. Regardless, you must hold EIS shares for at least 3 years to retain the tax relief.
However, you should also be aware that the EIS can carry a higher level of investment risk than VCTs due to the nature of EIS companies. In general, EIS-qualifying companies tend to be smaller with a lot more growth potential, but also carrying a higher risk of failure.
The Seed Enterprise Investment Scheme (SEIS) is similar to EIS, but with some important differences. Notably, you can only commit up to £100,000 per tax year into SEIS-qualifying companies or funds, but you can claim 50% Income Tax relief on the value of your investments.
Similar to the EIS, you must hold the shares for at least 3 years to retain tax relief and any dividends are also taxable (unlike VCTs). One important drawback to be aware of with SEIS is that companies that qualify for SEIS relief need to be very early stage and therefore the risks are higher than EIS qualifying investments.
VCTs, EIS and SEIS all offer some attractive benefits to especially higher rate tax payers which are well worth considering within your wider financial plan, especially as you approach retirement. However, their nature as a higher investment risk means that you should consult a Financial Planner about how to integrate these into your financial plan, prior to making any big decisions. If you would like to speak to us about this, then please do get in touch.