High Earners Consider VCTs As Pensions Alternative

Venture Capital Trusts [VCTs] bounced back in 2020/21, raising 4% more cash than the previous year and almost twice as much as a decade earlier. The current tax year is expected to see even more cash flood in, as investors shelter their money from dividend tax rises in April.

But while the tax benefits are impressive (30% income tax rebate on investment, tax free dividends and tax free growth), VCTs come with higher levels of risk, and as they old adage goes, don’t let the tax tail wag the investment dog.

Demand for VCTs waxes and wanes depending partly on rule tweaks. In 2019/20 demand fell back because the rules were tightened to restrict where VCTs could invest, which made them a riskier prospect. The change was made in 2017, but it took effect more gradually.

It’s also driven by changes in tax rules, and the 1.25% rise in dividend tax is expected to trigger a bumper year for VCTs.

Demand also soars every time pension allowances get less generous, forcing those with higher incomes and large pensions to look elsewhere for tax relief. They came close to record highs between 2017 and 2019, when the pension lifetime allowance dropped from £1.25 million to £1 million.

Tax-efficient investment gets more difficult as your income and your pension grow. The tapering of pension allowances for higher earners, the introduction of annual allowances and the shrinking of lifetime allowances have all meant investors looking elsewhere for tax relief.

ISAs are an obvious first port of call, but once the annual allowance is used (£20,000 per annum), investors could look to cast the net wider, and VCTs offer substantial tax perks.

The right VCT investment doesn’t just offer tax breaks, it also aims to offer capital growth and provide a stream of higher dividends, which look particularly striking at a time of lower interest rates.

Your investment objectives, however, should always be a key driver, and it may be that higher risk retirees may benefit more from VCTs and the dividends, while those higher earners in the accumulation phase, with no need for income, may be better served by EIS (Enterprise Investment Schemes). Look out for my coming guide to the tax differences of VCT, EIS and the EISs younger, riskier sibling, the SEIS.