For many people approaching retirement, they face a bit of a financial quandary.
It isn’t that they have too little money for retirement. Rather, the problem is they might possibly have contributed too much to their pension!
Is that even possible? Well, when you look at the situation in light of the Lifetime Allowance, t become clearer how having too much money in retirement might be an issue.
The Lifetime Allowance places a limit on the value of your pension pot(s). Once the pot goes over this threshold, then the amount that has gone over is liable to tax. In 2019-20, the threshold is set at £1.055 million. Anything above this could be taxed at either 25% or 55%, depending on how you choose to take the money.
This threshold has actually gone down in recent years. In 2010, for instance, you could keep £1.8 million in pension savings. The Annual Allowance has also changed (i.e. the amount you can contribute to a pension each year, without getting taxed). In 2010 you could contribute up to £255,000 without being liable to tax. In 2019-20, the limit is now £40,000.
All of this leaves some people in a bit of a pickle. What do you do if you have ten years until your retirement, for instance, but look set to go over the Lifetime Allowance – even if you made minimal pension contributions until then?
There is no universal answer to this question, and for most people speaking with a professional financial planner will help you identify the best options. For some people, Venture Capital Trusts (VCTs) might form part of the answer.
In the rest of this article, we’re going to briefly explain what VCTs are, how they work and how they can benefit a retirement plan. This content is for information purposes only and should not be taken as financial advice. For advice regarding your specific goals and financial situation, please contact a member of our team to arrange a free, no-commitment consultation.
VCTs: An overview
The name Venture Capital Trust might sound intimidating, but it actually is fairly straightforward.
A VCT is a highly tax-efficient way of investing your money into UK small businesses, such as startups. These businesses are not listed on the stock exchange, and whilst a VCT offers the chance for a high investment return it also entails a high degree of risk.
A VCT is, itself, a company. It is listed on the London stock market, and essentially it brings your money together with that of other investors to invest in small UK businesses. If those businesses make money, then so do you. Moreover, you get to keep more of it due to the tax incentives offered by the VCT structure.
Small businesses and startups are naturally more risky to invest in. Many of them will fail, which means you would lose your money. A VCT will attempt to spread out your risk by pooling your money will other investors, and investing it in lots of different small businesses which have been vetted / “stress-tested”.
To invest in a VCT, you can either buy shares from other investors who hold them in an existing VCT. Or, you can buy shares in a new VCT when it starts up. When you buy the shares, you get a 30% Income Tax relief on investments up to a total of £200,000 per tax year.
This is why VCTs have become quite an attractive option to lots of people approaching retirement, who are looking to minimise their potential tax bill by exceeding their Lifetime Allowance. You need to be careful though, as doing this yourself is likely to land you into trouble. Speak with an independent financial planner if you are considering this as an option.
For instance, certain conditions are imposed upon your use of VCTs. An important one to note is that you must hold shares in a VCT for a minimum of five years, if you want to retain the Income Tax relief. Bear in mind that it can also be difficult to find someone to buy your shares when you do eventually look to sell them.
One attractive feature of VCTs is that you do not pay Capital Gains Tax on any profits made from your VCT shares. The main condition is that the VCT you invested in must retain its status as a VCT, in order for you to retain this benefit. Any dividends you receive are also exempt from tax, although remember that you are not guaranteed to receive dividends.
Bear in mind that charges for VCTs tend to be high compared to other investments. Sometimes, a VCT will also levy a performance fee as well. So make sure you read the small print with your financial planner before committing your money.
Conclusion
VCTs are not a silver bullet for those facing tax constraints on their retirement plans, but they can be a viable option for some people with higher levels of wealth who are looking to minimise their exposure to needless tax.
Please be aware that with VCTs – and with any investment for that matter – your money is at risk and your investment value could go up or down, depending on performance. Whilst there is no compensation in the event your investment goes down, it is helpful to know that if your VCT goes bust then up to £50,000 of your money is protected under the Financial Services Compensation Scheme (FSCS).
On a final note, it’s important to say that we do not recommend VCTs are a replacement to sound retirement planning through a pension. VCTs can be a viable way to supplement your retirement plans and pension arrangements, but you should work with a professional financial planner in order to ensure these sit appropriately within your wider financial strategy.
