Your IndustryJun 30 2016

Using VCT and EIS as a pension supplement

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Using VCT and EIS as a pension supplement

According to Paul Sheehan, investment manager for WH Ireland, more people are starting to look at alternative means of income and tax-effective investing to help provide a comfortable retirement.

Mr Sheehan says: “Retirement planning is increasingly complicated, with pensions no longer providing the solution they once did for high-net worth investors.”

Add to the LTA reduction the introduction of the tapered pension allowance for those earning more than £150,000, and it is understandable why people are looking for ways to shore up their pension pots.

George Bull, senior tax partner for RSM UK, explains there are many reasons why people are starting to consider alternatives such as enterprise investment schemes (EIS) and venture capital trusts (VCTs) to boost their retirement income.

“Patterns of behaviour are changing, partly as people come to terms with the lifetime limit and the need for many to organise non-pension investment income for their later years.

“More people than ever are looking at alternative, tax-efficient investments”.

VCTs and EIS are not a straight replacement for a pension, given the niche nature of the assets and the higher-risk nature of these schemes. Jason Hollands

Data appears to bear this out. According to the Association of Investment Companies, funds raised in the 2015 to 2016 tax year for VCTs reached £457m, compared with £429m for the 2014 to 2015 tax year.

The amount raised by companies seeking funding through EIS reached close to £1.7bn in 2014 to 2015, according to the EIS Association, with similar figures estimated for 2015 to 2016.

However, Mr Bull adds: “But there is a world of difference between the treatment of pension contributions (the policy rationale for which is to encourage people to save for their retirement without incurring unacceptable levels of risk or investing in in appropriate assets), and EIS/VCT, where the availability of tax reliefs is accompanied by significant, higher levels of risk.”

VCTs

The main attraction for pension investors is the prospect of regular, tax-effective dividend income through VCTs.

“VCTs provide 30 per cent income tax relief on new investments, are free of capital gains tax and can pay tax-free dividends. The tax-free dividends from VCTs are particularly attractive from a retirement income perspective”, says John Glencross, chief executive of Calculus Capital.

He adds: “At a time when tax-relieved pension contributions are being severely curtailed through reductions in allowances, with additional restrictions on high earners, EIS and VCTs provide alternative routes to making tax-efficient savings.

“It is clear from conversations with intermediaries and investors more people who have been affected by these changes are considering these funds.”

There are various types of VCTs, which can also help focus investors’ choice on what might make a more appropriate investment to boost their pension pots.

A client might want to invest in Alternative Investment Market stocks and take advantage of the tax incentives available in Aim stocks, or invest for a set period of time, using a Limited Life VCT.

Four main types of VCT

■ Generalist VCTs - These VCTs invest in a wide range of companies in different sectors and stages of development.

■ Aim VCTs - As the name suggests they only invest in companies listed, or about to become listed, on the Alternative Investment Market

■ Specialist VCTs - Tend to focus their investment expertise on one particular sector, such as healthcare

■ Limited Life VCTs - Set out on a 5+ year plan and will wind up the VCT at the end of this period.

And, as Ben Thompson, group marketing director for the Foresight Group, says, the types of people putting money into VCTs and EIS are changing.

“In the case of VCTs, the minimum investment is just £3,000 with the average investor contributing approximately £16,000 a year. This indicates a high proportion of investors would not be considered super-rich or high net worth, but retail investors looking for flexible alternatives to pension planning.”

However, Jason Hollands, managing director for business development and communications at Bestinvest, warns against floods of money coming into the VCT sector.

He says: “We could see a mismatch between greater demand for VCTs this year and quality supply.

“Responsible VCT managers will not raise more money than they are comfortable they can find suitable deals to invest in, as they must be at least 70 per cent invested in qualifying companies within three years of launch, or this could see the loss of their VCT status.

For suitable investors, who have taken the appropriate advice, EIS can offer a tax-efficient investment structure and a generous set of tax breaks Paul Sheehan

“Given the narrower investment universe stemming from the recent changes to the rules, coupled with the fact a number of VCTs have just raised quite a bit of cash, it isn’t at all clear supply will meet the potential increase of demand.”

This is borne out by data from Interactive Investor, which reveals some new VCT issues have not yet raised their full amount - although there are several more months to go.

For example, the Pembroke VCT Generalist has raised has £3.8m of its £15m total.

EIS

EIS do not have tax-free dividends as VCTs do. Yet they can still play a part in overall pension planning, as Mark Brownridge, incoming director general of the EIS Association, explains.

He says: “EIS do not have tax-free dividends but we see them as being complementary to pension planning.

“Pension freedoms have been a game-changer in how people view their savings and investments and they are increasingly building different pots of money through different investments.

“EIS will certainly play a part in that.”

WH Ireland’s Mr Sheehan comments: “The case for investing in EIS for pension planning is strong, as for suitable investors, who have taken the appropriate advice, EIS can offer a tax-efficient investment structure and a generous set of tax breaks.”

EIS and VCTs also can help with overall pension planning in terms of what can be drawn down and when. Mr Thompson explains: “Once VCTs and EIS have been held for the minimum qualifying period, investors can access their funds in full with no further tax to pay.

“This makes them an excellent complement to pension planning, where typically just 25 per cent of accumulated funds can be accessed tax-free, with the balance taxed at the investor’s marginal rate.

“For those investors who wish to draw down more than the 25 per cent allowance on their pension fund, additional tax would be levied. This could be reduced or mitigated by investing into EIS or VCTs.”

Caution

However, regardless of trends among some investors, RSM UK’s Mr Bull does not think the use of EIS and VCTs as a supplement to pension income will become widespread.

He explains: “While I observe some investors using EIS/VCTS for annual investments once they have reached their pensions lifetime limit, others will look elsewhere because they are not comfortable with the levels of risk.”

Mr Hollands agrees: “It is important to understand VCTs and EIS are not a straight replacement for a pension, given the niche nature of the assets these invest in, and the higher-risk nature of these schemes.

“They can, however, be a valuable part of an overall financial plan alongside Isas, pensions and simply judicious use of capital gains tax allowances.”