Ever since the March 2014 Budget introduced the concept of ‘complete freedom’ for anyone with a pension, the way people invest for their retirements has become an industry – and media – obsession.
Yet so far the response from investors has been cautiously muted. The shackles that bound pensioners to annuities might have been removed, but after freedom, what comes next?
Such apathy is likely to change when the realisation sinks in that freedom on the one hand is competing with tighter restrictions, and potentially higher tax implications, on the other. Many clients – particularly those who have made good use of their pension allowances – have faced reduced annual and lifetime pensions allowances that are cutting off the amount they can invest into their pensions.
Because of this, now is the time to be making the case for tax-efficient investments, such as venture capital trusts (VCTs) and enterprise investment schemes (EISs), to be considered as part of overall retirement planning, both at the accumulation and decumulation stages.
But before considering how tax-efficient investments could complement existing pension arrangements, let’s make sure that the investment risks are placed in the right context.
Both VCTs and EISs are regarded as high risk. Those that do well have the potential for significant returns, but they don’t all succeed. If clients are not comfortable with the idea of investing in smaller companies that are not listed on the London Stock Exchange, then such investments aren’t right for them.
The performance of such investments can also be more volatile, which means that, over time, their values can fluctuate significantly. When it is time to sell there is a chance that the investment will have reduced in value. There are minimum investment limits and VCTs and EISs certainly won’t be suitable for everyone.
It is also important that the tax benefits aren’t allowed to overshadow the risks, particularly as the tax treatment for investors depends on their individual circumstances and may be subject to change. In addition, the availability of any tax reliefs also depends on the investee companies of each product maintaining their qualifying status.
For all these reasons there is no suggestion that VCTs or EISs could – or should – be used to replace pension planning completely. However, such products may have an invaluable role to play as part of a retirement planning portfolio, particularly for investors who have reached, or are coming close to, the limits of a traditional pension investment, and are looking to consider another tax-efficient string to their bow.
As one example, before retirement, a VCT could potentially be used as a long-term investment, with dividends reinvested to help their overall VCT pot grow. What’s more, an investor can keep reinvesting their VCT every five years to continue to benefit from upfront income tax relief, which is up to 30 per cent of the value of the investment. After retirement, the VCT could continue to provide a stream of tax-free dividends to help the investor to supplement their pension income, while the capital stays invested.
While those arriving at retirement might want to diversify their investments, many will still expect a degree of security and a balance of risk and reward. With the right advice, tax-efficient investments that complement pensions could potentially give an added dimension to retirement planning.
Paul Latham is managing director at Octopus Investments
Key figures
£17,000
Average expected annual retirement income of those planning to retire in 2015, according to Prudential
55
Minimum age at which people are able to access their pension pots. This age limit is due to go up from 55 to 57 in 2028 and will remain 10 years below state pension age
25%
Percentage of a pension pot that can be taken tax-free as a lump sum
