The season is about to begin, although dare I say it ever truly ends, but multiple promoters of Venture Capital Trusts tend to launch in the Autumn of each year and once it’s gone, it’s gone! Once they have raised their quota of capital for the year, it’s over until the next one.
Sounds a bit scary
If you don’t like risk, you might think they are a bit scary! VCTs are a tax advantaged investment. That is, they benefit from a number of government incentives in the form of tax breaks to encourage investment in areas that would be good for the U.K. economy. Principally this means start up companies. Should they succeed and grow, they will employ thousands of people and the government will there recoup the incentive in higher income, corporation taxes and national insurance contributions.
The incentive
When you pay into a VCT, you get a 30% income tax refund on what you have paid in. So, if you have paid enough income tax and paid £20,000 into a VCT you would get an Income tax reduction/refund of £6,000.
Then, any dividends or capital gains you receive from the VCT In future are also completely tax free.
Dividends
Typically, VCTs pay around 5% a year in a dividend, although amounts, size and payment dates are variable and not guaranteed. Most offer the ability to recycle that dividend back into the investment, thus getting another 30% income tax refund. This is a virtuous circle of wealth building!
If you were a higher rate income tax payer you would pay 33.75% on a dividend. A tax free dividend is equivalent to a gross return of 7.55%.
If you recycled that dividend and got a further 30% income tax relief then it would be equivalent of 9.05%.
What’s the catch
They’re small, U.K. based companies. As you know, we usually preach global diversification for your investment but in this case, they must be based in the UK, that’s why you get the tax incentive.
Smaller companies are more likely to go bust. As such, you could lose all of your money. However, most VCTs typically invest in 30-50 start up companies with the largest around 80. Some will surely go bust, just as others will be successful.
Also, you have to keep them invested for 5 years at least. If you liquidate before then, you’d have to repay the income tax refund you got. In reality, they are illiquid anyway, and so you are likely to need to keep them a lot longer and have in mind to keep for ten years, I would argue, and continue to reap the dividend.
Essentially, they are much higher risk. The valuation will fluctuate wildly and you cannot sell out of them whenever you want.
The investment charges are quite high compared to standard investments. That’s because the investment teams that back them are adding in their ‘business management’ experience to ensure they can scale as quickly as possible to be in a position where the investment money can be returned as quickly as possible. Smaller companies are simply more expensive to invest in.
There is a limit of £200,000 per person that can be invested in VCTs in any one tax year.
Top tips
The investment amounts required for VCTs are quite low, with £3,000-£5000 often the minimum. This can allow for investment in several different ones, meaning good diversification of your investments.
Don’t invest purely for the tax advantages. Invest because they are good investments and then reap the benefit of the tax advantages.
VCTs could be considered by:
Higher rate tax payers who have used up all pension contribution & ISA allowances.
Business owners with a large amount of money in the company and seeking to extract it tax efficiently. Withdrawing some money would mean paying 33.75% to 39.35% in dividend tax, then investing the money into VCTs would see a refund of 30% tax. Thus, extraction from the business only costs 3.75% to 9.35%.
Retired with large pension funds – You are retired, your pensions are above the Lifetime Allowance and the ‘crystallised’ part of your pension is growing quicker than you can spend it (thus increasing Lifetime Allowance issues). You have refrained from drawing more to avoid income tax. This enables you to withdraw some, pay the income tax and then invest into a VCT to get income tax refunds. However, consideration to your inheritance tax position should be considered here.
Landlords with income you don’t need but can’t stop. Save some of the tax by investing in VCT.
Higher rate tax payers forever – Are you always likely to be a higher rate income tax payer, even after you have retired? If so, you need to set up investments that will enable you to manage your levels of taxation in retirement. VCTs, with their tax free income are a useful part of this planning.
Want to find out more?
If you feel VCs may be something that could be useful to you, please do contact us. I recommend you absolutely do not try to do these yourself. First, you need to check your tax situation is suitable, but more than that, you need to ensure the investments and track record of them is suitable. This takes in-depth knowledge and analysis. To that end we use the services of the Tax Efficient Review (https://www.taxefficientreview.com) to help us evaluate the investments within a VCT and also to review track records of the providers.
If you are new to us, we won’t solely advise on these for you.
We won’t do any investment advice for you unless:
You have a full financial plan that we have devised
We manage all of your pensions and investments
These make sense for your situation and are suitable for you.
For existing clients, if we feel these are suitable for you, then we will have spoken about them and be contacting you in the near future.
Key risks
Investments can go down as well as up
You could lose all your money
Tax advantages may be withdrawn in the future
Liquidity risk – if you need to, you will unlikely to be able to withdraw your money when you want.
This article does not constitute financial advice – we recommend you to speak to a qualified financial adviser about your individual situation.
We hope you found this article interesting and useful.
If there are any specific topics you’d like us to cover in an upcoming issue, please let us know by emailing support@lucentfinancialplanning.co.uk and we’ll see what we can do!
This article does not constitute financial advice. We recommend that you speak to a qualified financial adviser for advice tailored to your individual circumstances and goals. Financial markets may go up or down, and you are not guaranteed a return on your investment. Past performance is not necessarily a guide to future performance.
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