Are Venture Capital Trusts the perfect pension supplement?

The rise in popularity of Venture Capital Trusts (VCTs) has taken place over a time when the pension Annual Allowance and Lifetime Allowance have been systematically throttled by HMRC. Of course, there are other tax-efficient savings vehicles available for your clients; ISAs being the go-to recommendation for any financial adviser worth their salt, but VCTs offer an attractive alternative to traditional pensions for long-term savers that have used their £1.03 million Lifetime Allowance.

A quick recap

Introduced in 1995 and designed to encourage growth of UK businesses and the economy, VCTs are investment companies listed on the London Stock Exchange that invest in small businesses whose shares are not listed on a recognised exchange. The underlying businesses must meet strict criteria and are typically small, young and looking for investment to fund growth. Generous tax relief is one of the primary attractions, as VCTs offer;

  • Income Tax relief of 30%, up to a maximum investment of £200,000 a year, although this can be reclaimed by HMRC if you sell your shares within five years
  • Dividends from VCTs are also free of Income Tax, provided the original investment was made within the permitted £200,000 maximum
  • They are free of Capital Gains Tax on gains from investments, with no minimum holding period for this rule to apply

Figures from HMRC show that in 2016/17, 15,120 investors claimed £500 million of Income Tax relief, a 15% increase on the previous year. As a long-term investment with potential for growth and a tax planning opportunity, a VCT might be a valuable proposition as part of a client’s diversified portfolio. However, we recognise that as a financial professional you may have some objections, so let’s address the three main culprits; the cost, potential risk and availability.

The cost of VCTs

Historically, VCTs were viewed as prohibitively expensive, despite the initial Income Tax relief. There was a feeling that as investors were effectively locked in for five years, VCT managers were able to charge disproportionately high fees considering the service delivered. Charges were a little convoluted, consisting of initial charges, management fees, ‘normal running costs’, arrangement fees and performance fees.

Today there is more transparency, simplicity and competition. Fees remain a little higher than wrap and investment fund alternatives, with ongoing charges typically ranging from 2% to 4%.

Ultimately, managing a VCT is a specialist proposition requiring experience and expertise. Investment due diligence, specialist administration and negotiating investment sales all lead to higher running costs than other investment companies.

Investment risk and performance

VCTs are potentially higher risk by nature, investing in small, younger companies. They tend to be riskier than well-established public companies, but that is a big generalisation and certainly not a given. The merits of individual investments and the research into their likely sustainability and potential for profit are often determined by rigorous due diligence.

Whilst VCTs are illiquid and the tax benefits are dependent on the underlying investments adhering to strict rules, they can be extremely financially rewarding. As with any investment, the experience of the manager and previous track record, whilst zero guarantee of future performance, should be taken into account.

Transparency has improved in recent years, and tools such as Trustnet who risk score VCTs as well as publish performance, help to make informed decisions. In fact, some VCTs attract volatility ratings lower than the FTSE 100, so their reputation for especially high risk across the board is undeserving.

With increased volatility in traditional markets and political and economic uncertainty around Brexit, any investment decision for your client needs to be well researched and aligned and within their attitude to risk and capacity for loss. Naturally, this is where an experienced, Chartered financial planner can really add value.

Capacity and availability

Thanks to the criteria qualifying businesses have to meet, VCTs are limited in their capacity. With popular VCTs being fully subscribed by November, demand is far outstripping supply and if clients leave it too late in the tax-year to invest, they are likely to be disappointed.

Figures from the Association of Investment Companies show that VCT fundraising for 2017/18 was close to an all-time high, raising £728 million. That’s the second highest investment since VCTs were introduced in 1995 and an increase of 34% on last year’s figure of £542 million. But, the number of VCTs managing funds actually fell from 75 to 70 in 2017/18, further increasing competition to invest.

It’s not unusual for clients left to their own devices to leave ISA and pension contributions to the last minute. But client and financial planners alike need to be much more proactive with VCTs, especially as the annual tax allowance does not roll over to the next year.

If you see clients that have maximised their pension savings and are looking for a tax-efficient alternative for long-term savings, depending on their circumstances, a VCT might just be the answer. But, as we’ve demonstrated, we need to act sooner rather than later. At Sovereign, we are independent, Chartered Financial Planners with significant experience in this area. Please feel free to get in touch directly or introduce our services.

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