Our previous piece, Understanding venture capital trusts, discussed the growing popularity of VCTs, the importance of diversification, selecting the right VCT, tax advantages, and potential risks. We’re now diving into real-life examples of how advisers use VCTs in their day-to-day financial planning with clients.
The following three scenarios give some examples of how financial advisers are using VCTs in their regular financial planning. Remember, these examples are not financial advice, and VCT investments are high risk, meaning they are not suitable for all investors.
Using a VCT to offset taxes on pension income
Retired clients often find it frustrating that money withdrawn from their pension is still subject to income tax. As an example, Marie recently retired with a pension pot of £800,000. She wants to take out £50,000 from her pension, of which 25% (£12,500) will be tax-free, while the remaining £37,500 will be taxable.
After Marie’s income tax-free allowance of £12,570 is considered, £24,930 is subject to income tax. As a basic rate taxpayer, Marie’s pension withdrawal of £50,000 leaves her with an income tax bill of £4,986.
However, there is a way to ensure Marie, and other retirees like her, pay zero income tax on pension income withdrawals.
Marie’s financial adviser talks to her about the benefits and the risks of investing in a VCT and explains that if she invested £16,620 in a VCT, she could claim 30% income tax relief on her investment which, at £4,986, matches her income tax liability. This effectively makes Marie a non-taxpayer.
Marie can also expect to receive an annual tax-free income from her investment as most VCTs have an annual dividend target. The potential for regular tax-free VCT dividends is particularly attractive for retirees like Marie, especially considering the dividend allowance falls to just £500 from 6 April. As a reminder, basic rate taxpayers will be required to pay dividend tax at a rate of 8.75%, while higher rate taxpayers will pay 33.75%.
How higher earners can reduce their tax burden through a VCT
High-earning clients can still find themselves facing financial challenges or with liquidity needs in the not-too-distant future. For example, Reuben is a 42-year-old Finance Director with an annual salary of £150,000 who recently received an annual bonus of £50,000. He initially considered paying that bonus into his pension, probably the most tax-efficient option available to him, but is mindful that any large sums put into his pension won’t be accessible until he turns 55. He would rather not keep his money tied up for that long.
Reuben discusses his situation with his financial adviser, who explains the benefits and the risks of investing in a VCT. His adviser tells him that investing £50,000 into a VCT, would allow Reuben to claim £15,000 income tax relief on the investment, provided he keeps his VCT shares for the minimum five-year holding period. Reuben could also expect to receive an annual tax-free income from his investment in the form of VCT dividends.
Those tax-free dividends are especially attractive for high earners like Reuben, considering additional-rate taxpayers would require an annual gross return of more than 8% from a unit trust or investment trust to match the income earned from a 5% tax-free VCT dividend.
Making recurring VCT investments
Investors like Jenna may find it even more tax-efficient to make VCT investments year after year. Jenna recently invested £100,000 into a VCT, and if she does this for the next five consecutive years (year one to year five), the total amount invested would be £500,000. Jenna would have been able to claim 30% income tax relief on her VCT investment each year (£30,000), offsetting a sizeable portion of her annual income tax bill.
In year six, Jenna can sell her VCT shares from year one, reinvesting the proceeds in a new VCT investment. She can sell her year two shares to buy new VCT shares in year seven, and so on. While the total amount invested by Jenna stays at £500,000, she can claim income tax relief on new VCT shares bought each year, while continuing to enjoy tax-free growth and regular dividend payments.
Those were just three example scenarios where tax planning through a VCT can suit a specific set of circumstances. However, VCTs can help with a range of issues faced by clients at various stages in their financial journey.
Importantly, from an advice perspective, VCTs are an established way to deliver value-added services to clients that can set you apart from the advice given by other financial planners. With Consumer Duty considerations firmly front of mind, introducing VCTs into client conversations can help demonstrate an expansive and solutions-based approach to financial planning they may struggle to find elsewhere.
Diana French is retail strategy director at Triple Point
