Changes to pension legislation have meant that advisers and paraplanners are looking at different ways to help clients make the most of tax-efficient investments as the tax year-end approaches. Downing LLP highlight some case study examples of how using VCTs can be used as part of the retirement planning process to help clients build up capital for retirement.
From 6 April 2016, the government introduced changes to the pension tax relief system, including a new annual allowance taper for higher earners which reduces the maximum annual contributions eligible for tax relief. We consider two scenarios where advisers and paraplanners may consider the use of Venture Capital Trusts (VCTs) as part of the client’s financial plan.
Case study 1 – retirement income planning
42 year old Carlos is an employee earning £250,000 per year, making him an additional rate tax payer. He has historically contributed £2,000 a month to his pension pot, however with the annual allowance taper his annual contribution is reduced to £10,000 (at a net cost of £8,000 including 20% pension tax relief at source). Carlos would like to continue contributing £2,000 each month and decides to speak to his financial adviser about other ways of planning for retirement income.
Having discussed Carlos’ goals and assessed his risk tolerance, Carlos’ adviser suggests that he could complement his retirement pot by investing in a Venture Capital Trust (VCT). She highlights the fact that VCTs invest in smaller companies that aren’t listed on a major stock exchange, so they are higher risk than typical pension funds. Carlos is comfortable with that and can take a long term view on investment returns. He is not expecting to retire until he reaches the age of 60 at least. On hearing from his adviser that VCTs offer 30% income tax relief (up to a maximum subscription of £200,000 per tax year) and the potential for tax-free growth and income, he feels that using VCTs is an excellent way to help him to plan ahead for his retirement alongside his pension assets.
Case study 2 – the annual allowance taper
Clients with an income above £150,000 per year will see their annual pension allowance reduced by £1 for every £2 of excess income. Those clients with incomes of £210,000 and more will have an annual allowance of just £10,000.
From 6 April 2016, clients with an income above £150,000 per year have seen their annual allowance reduce by £1 for every £2 of excess income. The maximum reduction is £30,000; as illustrated in the graph below, this will be reached by clients with income of at least £210,000, resulting in an allowance of just £10,000 in the 2017/18 tax year.
Anthony is 50 years old and earns £250,000 per year, making him an additional rate tax payer. He has fully funded his pension each year in order to maintain his current lifestyle in retirement from age 60. Consequently he has no availability to carry forward pension contributions that he has not utilised in previous tax years. Historically, Anthony made a gross pension contribution of £40,000 a year as part of his retirement planning strategy and has that amount available to invest again for the tax year 2017/18. Anthony’s annual allowance will be restricted to £10,000 for the 2017/18 tax year following the changes in pensions legislation. This means he will pay more income tax and would accrue less retirement income than in previous tax years.
A potential solution
Anthony’s adviser suggests that he could enhance his retirement pot by investing in a Venture Capital Trust (VCT). They discuss the fact that VCTs invest in smaller companies which aren’t listed on a major stock exchange. As a a result they are higher risk than typical pension funds, however this is something that Anthony is comfortable with – it is in line with his risk tolerance. The fact that VCTs offer 30% income tax relief (up to a maximum subscription of £200,000 per tax year) and the potential for tax-free growth and income makes them an appropriate consideration in this situation. VCTs may also provide a suitable alternative for clients aged over 40 years and who will not have access to the Lifetime ISA.
Comparing a VCT with some other tax planning options
Of course, these examples are for illustrative purposes only. Investors’ capital is at risk and returns are not guaranteed, tax reliefs are subject to personal circumstances and that the VCT maintaining its qualifying status and may change. VCTs are long-term investments and shares should be held for a minimum of five years to qualify for the available tax reliefs.