As pensions have a tax-efficient lifetime allowance, it’s not surprising that many investors question why they would keep adding to their pension pot if it is going to be heavily taxed at a higher rate later down the line.
These restrictions have resulted in a search for alternative tax-efficient investment planning, and two of the most frequently considered options are Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EISs).
Over the last 25 years, successive governments have encouraged investment into these schemes, which back early-stage businesses (and are hence higher risk) by offering various tax reliefs as compensation for those risks.
Not only is there income tax relief at 30% on both schemes, but capital gains are exempt from tax too (whilst held in the account). Given the recent announcement about the increase in dividend tax, the fact that dividends are tax-exempt in VCTs is attractive, whilst EISs offer loss relief, with individual company losses being offsetable against income as well as capital gains.
For an additional rate taxpayer, this means that exposure to loss is just 38.5% of the original capital invested, with the government effectively underwriting a huge chunk of the risk.
By combining the various tax reliefs (including inheritance tax, which EISs qualify for exemption after two years), in theory it is possible to receive a combined tax benefit of 98%!
However, it is important to understand the risks before making a decision to invest in VCTs and EISs. By their nature they are high risk, their share price may be volatile, and they may be hard to sell. The value of the investment can fall as well as rise, and you may not get back the full amount you invest.
You will also need to be comfortable holding the shares for at the very least three years (EIS) or five years (VCT) in order to keep any income tax relief claimed. There is a delay in your money purchasing shares in the individual companies, and then a delay in timing the best exit strategy.
In addition, tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on these investments maintaining their qualifying status. As ever, independent expert advice is essential.
But with those caveats, both Venture capital Trusts and Enterprise Investment Schemes can be a good option, especially for higher and additional rate taxpayers who have exhausted their pension and ISA investment allowances. Covering income tax, capital gains tax and inheritance tax, few investment structures tick as many tax planning boxes.