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Why demand for VCTs is growing

5 Dec 2017

This article first appeared in Professional Paraplanner.

Venture Capital Trusts (VCTs) are increasingly seen to be an important part of the retirement planning armoury. That’s reflected in the size of inflows into VCTs, which totalled £542 million in the 2016/17 tax year. That’s the second-highest on record, and an 18% jump on the previous year[1].

Two recent changes are helping to drive this increased demand. Firstly, the Government has reduced the amount people can put into their pensions, prompting them to find alternative tax-efficient ways to put money aside. In addition, recent changes to buy-to-let (BTL) have made property investing less effective for retirement planning.

Financial advisers have found that the tax benefits of VCTs make them an attractive alternative option for clients who are comfortable holding a higher risk investment. To better understand how VCTs fit into retirement planning, and to explain their recent rise in popularity, we should start by looking at how legislative changes have made traditional solutions less attractive for some.

Limits on pension contributions have become more restrictive

For those approaching retirement age, the simple fact is that pensions have become more complicated. For example, the amount individuals can pay into a personal pension over their lifetime has almost halved from £1.8 million in 2011 to just £1 million.

It’s true that the lifetime allowance is set to increase with inflation, starting in April in 2018. However the penalty for breaching the new limit is a hefty tax of up to 55% on the excess. Rather than risk it, people are looking for alternatives to complement their existing arrangements. As well as the lifetime allowance, the Government has also reduced the annual allowance. This states how much an individual can put into a defined contribution scheme each year while still receiving tax relief. In 2010 the annual allowance was £255,000. It’s now just £40,000.

Buy-to-let has become less tax efficient

Many people have invested in bricks-and-mortar as a way to complement or even replace pension planning. However, recent measures have made this less tax-efficient. These include a 3% stamp duty surcharge on the purchase of buy-to-let properties and second homes and, more recently, the phased reduction in tax relief on mortgage interest.

Previously, landlords could deduct 100% of their mortgage interest payments and other finance-related costs from rental income. This reduced their overall tax liability. Now, though, this has been replaced by a 20% basic rate tax relief, which can be used to offset income tax. This is likely to push many property owners who were paying income tax at the basic rate into the higher rate bracket.

From the conversations we’re having with retirement planners, it’s clear that these changes have prompted a lot of landlords to look at alternative strategies that can complement their existing retirement portfolios.

VCTs offer straightforward tax benefits

With investors facing more taxation on both their pensions and their property, the recent surge in VCT inflows makes perfect sense, not only for investors but also for the Government. Recent buy-to-let changes combined with ongoing support for VCTs have, in effect, redirected the marginal cost of giving tax relief to landlords and put that money to work in Britain’s brightest young businesses. It’s a pragmatic way to create jobs and stimulate economic growth.

For investors, VCTs can play a distinct role in a portfolio. They should be considered high risk, as they invest in small, early stage companies with high growth potential. Investors need to be aware that they may not get back the full amount they put in, and that VCT shares can be more volatile than shares of larger companies listed on the London Stock Exchange’s main market.

For clients comfortable with the risks of investing in smaller companies, VCTs offer easy access to an exciting sector of the market. They can give clients exposure to a broad portfolio of young and more mature companies that are already trading, including unquoted companies.

They also offer some attractive tax benefits if the investor holds the VCT for at least five years:

  • 30% upfront income tax relief.
  • Tax-free dividends
  • Exemption from capital gains tax should the shares rise in value.

VCTs can also end up providing a good stream of tax-free dividend income, though this isn’t guaranteed. The average VCT yield is around 8.5%.[1]

In addition, managing a VCT investment tends to be relatively straightforward. In our experience, shares are typically allotted within two-to-three months, from which point the five-year holding period starts. Investors receive a single share certificate and a single tax certificate, which they can use to reduce their income tax bill that same tax year. It’s important to note that tax treatment depends on individual circumstances and may change in future, and that tax reliefs depend on a VCT maintaining its qualifying status.

Supporting the backbone of the UK economy

VCT investors are tapping into the UK’s vibrant entrepreneurial scene. Since 2010, the UK has gone from having just one tech company valued at over $1 billion to having 18. Three times as many venture capital deals happen here than in the next biggest European market[2]. One of those companies is Zoopla, the property website, which was funded by the Octopus Titan VCT. Of course not every VCT investment will create $1 billion companies.

Just last month, the Chancellor highlighted the importance of growth companies, the backbone of the UK economy. The Autumn Budget recognised the vital roles VCTs play in supporting these companies. Even in these cash-strapped times the Treasury has seen it appropriate to continue to support individuals who invest into VCTs by increasing the ability for them to invest into knowledge intensive companies which are at the heart of economic growth for the UK.  Compare this to the increased restrictions on pensions and BTLs mentioned above and it is clear that the government sees that VCTs are an efficient incentive for individuals to invest, as they have for over two decades. 

As the Budget made clear, the tax reliefs that VCTs offer are an incentive to take on the risks of backing early stage businesses. More and more investors are heeding that call, while at the same time using those tax reliefs to more effectively plan for their retirement.

[1] Source, Association of Investment Companies, July 2017

[2] Source: Markit 2010 and GP Bullhound Research 2016 and 2017

[1] Source, HMRC Official Statistics, 19 October 2017

For journalists in their professional capacity only. The value of an investment, and any income from it, can fall as well as rise. Investors may not get back the full amount they invest. Tax treatment depends on individual circumstances and may change in the future. Tax reliefs depend on the VCT maintaining its VCT-qualifying status. VCT shares could fall or rise in value more than other shares listed on the main market of the London Stock Exchange. They may also be harder to sell. Personal opinions may change and should not be seen as advice or a recommendation. We do not offer investment or tax advice. We recommend investors seek professional advice before deciding to invest. This advertisement is not a prospectus. Investors should only subscribe for shares based on information in the prospectus, which can be obtained from octopusinvestments.com. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: December 2017