It's an exciting time for Venture Capital Trusts (VCTs), set up by the government in 1995 to provide long-term finance to some of the UK's brightest smaller companies. For people comfortable with the risks of investing in UK smaller companies, VCTs offer a number of tax benefits.
But it's not just the tax benefits that are making VCTs attractive to investors. Significant reductions in the pension lifetime allowance have led people to look at VCTs in a new light, especially if they have accumulated a significant pension pot over their lifetime.
Investing in buy-to-let property has historically been a way for many to complement more mainstream pension planning, but recent changes to buy-to-let tax rules have now made this option less advantageous for landlords.
Against this backdrop, it's perhaps not surprising that interest in VCTs has risen dramatically in recent years as people are being forced to think more holistically about how they plan for the retirement they want in a tax efficient manner.
If you didn't already know, Venture Capital Trusts (VCTs) have been around for quite a long time. They were introduced by the government in 1995 to encourage investment in the UK's smaller entrepreneurial businesses in order to drive economic growth and job creation. VCTs support these types of companies, which are usually under-served by traditional finance methods.
Demand for VCTs is on the rise. According to the Association of Investment Companies, VCTs raised £542 million in the last tax year, the second-highest fundraising year on record and an increase of 18% from the previous year[1].
Investor appeal
For people comfortable with the risks of investing in smaller companies, VCTs offer a number of tax benefits in return for taking the risk of investing in UK smaller companies. A key attraction of VCTs is their ability to pay tax-free dividends, although these aren't guaranteed, while allowing the investor to benefit from up to 30% upfront income tax relief provided they are willing to remain invested for at least five years.
You should always remember that the value of an investment, and any income from it, can fall as well as rise and you may not get back the full amount you invest. The upfront tax relief is there, in part, to offset the high risk associated with investing in a VCT. Tax treatment will depend on your individual circumstances and tax incentives may change in the future. The tax reliefs also depend on the VCT maintaining its VCT-qualifying status. VCT shares could fall or rise in value more than other shares listed on the main market of the London Stock Exchange. They may also be harder to sell.
But it's not just the tax benefits that are making VCTs attractive to investors. VCTs have gained prominence by virtue of changes to other traditional methods of planning for retirement.
Pension challenge
Changes to the lifetime allowance have helped people to look at VCTs in a new light, as a means of complementing existing retirement planning strategies. For example, you may have accumulated a significant pension pot over your lifetime, and are now grappling with the concern that you risk hitting the lifetime allowance even if you make only modest future pension contributions.
The pension freedoms that were announced in April 2015 - which scrapped the requirement for retirees to buy an annuity - has the potential to boost demand for products such as VCTs that aim to generate a steady stream of tax-free dividends for investors, although dividends are not guaranteed. Of course, a VCT that invests in high-risk companies shouldn't be considered as a replacement for pension investments, which will typically be lower risk.
Landlords are also feeling the pinch
Many people have opted to invest in property as a way to complement or even replace pension planning. However, a series of measures − including a 3% stamp duty surcharge on the purchase of buy-to-let properties and second homes and, more recently, the phased reduction in tax relief on mortgage interest - has made this less tax-efficient. It's feared that property owners who were previously paying income tax at the basic rate may be pushed into the higher-rate tax bracket, despite their effective income from the property staying the same. With property investors potentially facing increased taxes, less relief and lower allowances, the recent rise in people looking at investing into VCTs is perhaps not surprising. Again, it's important to note that a VCT that invests in high-risk smaller companies shouldn't be considered as a replacement for property investments, which will typically be lower risk.
VCTs for retirement
While VCTs carry a higher risk profile, what's becoming increasingly clear is that more investors are keen to broaden their horizons, and are ready to look at complementary options, including VCTs, as a means to fund retirement. Provided the VCT is suited to your client's needs and attitude towards risk, there are many reasons to consider VCTs.
Octopus can help you and your clients
Octopus is the largest provider of VCTs in the UK (source: The Association of Investment Companies, April 2017). For a conversation about how VCTs may benefit your clients, call 0800 316 2067 or visit octopusinvestments.com.
[1] Source: The Association of Investment Companies, 10 April 2017, ‘VCT Fundraising for 216/17 the second highest on record' http://www.theaic.co.uk/aic/news/press-releases/vct-fundraising-for-201617-the-second-highest-on-record
Important information
For professional advisers only. Not to be relied upon by retail investors. This information is based on our understanding of tax rules as at October 2017. Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. We may record telephone calls to help improve our customer service. 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. Issued: October 2017. CAM05746.
