Why would you consider using venture capital trusts (VCTs) when saving for your retirement? Here’s one reason: dividends over a certain level can be taxed up to 38.1% as an additional rate taxpayer. But dividends paid to you via a venture capital trust, or VCT, are tax free.
It is not hard to see why many now view VCTs as a key part of retirement planning. While they are not a like-for-like replacement for a pension, they can offer an attractive line of supplementary income after working life. But there is more to VCTs than just tax-free dividends.
Advantages of VCTs for retirement planning
Limits for annual pension contributions (£40,000) and the lifetime pension allowance (£1,055,000) are now a fraction of what they were a decade ago. Those who exceed these limits risk being taxed punitively, but VCTs are not included in this limit – they fall under a separate cap, currently set at £200,000 a year.
Adding to their usefulness, VCTs also come with an income tax deduction of 30% of the amount invested. This can act both as a significant risk counterbalance or an added bonus should the investment do well. Any capital gains made on the VCT are also free from tax.
For those investors hitting their pension allowance limits, this extra headroom can help them put savings to work and enhance retirement income in a tax efficient way. Equally, the income tax deduction can be very useful if an investor has a significant tax bill to pay for the year – perhaps they have received a particularly generous bonus before retirement.
Taken together these qualities are often ideal for someone approaching the end of their working life who wants to optimise their retirement finance strategy.
Another benefit of VCTs stems from the fact that they are invested in unlisted companies. Check how early-stage the companies in a portfolio will be. The younger a company the higher the risk, generally. We tend to invest in companies in the ‘scaling-up’ process – in other words, they are more developed than start-ups. Some of these businesses could have the potential to grow very quickly. And they retain the benefit of having a lower correlation to listed companies, so VCTs can also add diversification to a portfolio.
Things to be aware of
It is important to remember that you must hold any investment in a VCT for at least five years, or you risk losing the tax relief benefits and being forced to pay them back.
Also, as with any tax relief investment scheme, keep in mind that VCTs are ultimately designed to encourage investment into growth companies. These are the future of the UK economy, but that does entail greater risk than investing in larger, public market companies. VCTs are not a replacement for a pension, they should only ever be used as a supplement.
VCTs are sometimes confused with Enterprise Investment Schemes (EISs), but the two are entirely different investment schemes. VCTs, for example, do not offer Capital Gains Tax deferral, whereas EISs do (but EISs lack tax-free dividends, so they are less suitable for supplementary retirement income).
Though there is a secondary market for VCTs it is limited. Investors offered the opportunity to buy VCTs on the secondary market should know that they do not come with tax reliefs.
The minimum investment amount will depend upon the VCT in question. For the Calculus VCT it is set at £5,000. Those who invest in a VCT in the run up to retirement might want to consider reinvesting the dividends (if it is an option). The dividends will then accrue further shares in the VCT over time, meaning that when it comes to retirement, the eventual dividend income should be higher.
Where to find your VCT
Investors have a wide variety of options available to them. Specialist VCTs, as the name suggests, are narrower and more suitable for investors who want exposure to a specific sector. Generalist VCTs, for example, invest in a more diversified portfolio of companies from different kinds of industries, offering exposure to a variety of sectors, which can reduce risk. AIM VCTs invest in companies listed on the Alternative Investment Market.
It is worth considering your wider portfolio when deciding which VCT approach is right for you.
Further reading: Why VCTs are a great way to invest in start-ups