If your firm has clients who are high earners, it makes sense to be familiar with venture capital trusts. VCTs are a powerful planning tool for clients in a variety of different scenarios, and can be a good way to add value to the client relationship.
In a moment we’ll look at some client scenarios in which a VCT investment could form part of the planning. Before that, let’s take a few moments to look at what VCTs are and how they work.
A quick refresher on VCT tax reliefs
The government created VCTs in 1995 They enable investors to claim certain tax reliefs, which act as an incentive to invest in high-risk, high growth potential early-stage businesses. Under the current rules, a VCT investor can claim upfront income tax relief equivalent to 30% of their VCT investment on investments up to £200,000 per tax year. Capital gains and dividends are also tax free.
As you’ll see in a moment, the fact that investors can claim upfront income tax relief makes VCTs a useful planning tool in a variety of scenarios. However, it’s important that clients are fully aware of the risks, as this type of investment won’t be suitable for everyone.
What are the risks?
VCTs invest in smaller, less established companies. The value of a VCT investment, and any income from it, can fall as well as rise and investors may not get back the full amount they invest.
Clients should also be aware that the share prices of VCTs may be more volatile than other shares listed on the main market of the London Stock Exchange. They can also be harder to sell.
Also bear in mind that tax treatment depends on individual circumstances, and tax rules could change in the future. Tax reliefs also depend on the VCT maintaining its qualifying status. Clients will also need to hold a VCT investment for five years, or otherwise pay back any upfront income tax relief claimed.
Client situations in which a VCT may help
Restrictions on pension contributions have left many clients looking for additional tax-efficient ways to invest towards their retirement. While it’s true that fewer clients will be affected by the annual allowance after the threshold and adjusted income limits were raised this year, those that are face a lower tapered annual allowance.
Of relevance to more clients is the lifetime allowance, which appears to have been a motivation behind a lot of VCT cases in recent years. This rose to £1,073,100 this year, the lowest level to which the government could have increased it under current rules. The lifetime allowance remains a material constraint on tax-efficient pension saving for a lot of people. And of course, high earners who take advantage of any increase in their annual allowance can expect to find themselves butting up against the lifetime allowance sooner than they otherwise would have.
Clients will typically be in their accumulation phase for twenty to thirty years. High-earning clients could spend around half of this period making enough in income to use up their pension and ISA allowances, or worried about exceeding the lifetime allowance.