The smaller picture

High earners and serious savers find it harder to use pensions to keep wealth beyond the grasp of the taxman, since the Treasury tightened the rules.

That’s the bad news. The good news is that very special types of investment trust, known as Venture Capital Trusts or VCTs, can help everyone keep more of what we earn and set aside for the future.

But it is important to beware the risks as well as the rewards of these funds that invest in small businesses and start-ups because not every acorn grows into an oak. VCT investors earn our tax breaks by surrendering access to our money for five years and running the risk we may never see it again.

However, I know from personal experience how VCTs can attract 30% initial or upfront tax relief and helped me avoid a substantial HM Revenue & Customs (HMRC) bill I faced over five years ago. Since then, according to independent statisticians Morningstar, the two VCTs in which I invested have delivered tax-free share price returns of 56% and 48%, compared to an average of 39% for the VCT Generalist sector.

Less happily, even after the minimum holding period of five years has expired, my VCT shares continue to trade 33% and 19% below their nominal value or the price I paid before taking into account the 30% tax relief I received.

More happily, while my VCTs continue to deliver tax-free yields of 9.24% and 6.25% respectively, I can see no reason to sell. Such high levels of tax-free income are not available elsewhere.

However, hopefully looking further out, it is important to remember that VCTs - like individual savings accounts or Isas - enjoy no exemption from Inheritance Tax (IHT).

Here and now, more people are considering VCTs since the maximum anyone can shelter in a pension was restricted to £40,000 a year. Anyone earning more than £150,000 a year has their maximum pension contribution further reduced by a taper until those earning £210,000 or more are restricted to a maximum pension contribution of £10,000 a year.

If, like me, you have already used pension freedoms introduced in 2015 to draw income or capital from your pension in addition to the tax-free lump sum or 25% commutation, then the maximum you can subsequently put into this tax shelter is reduced to £4,000 a year.

Even people still at work may find their access to pensions effectively restricted if they have been serious savers for many years and the total value of their retirement fund exceeds £1,030,000. This is known as the ‘lifetime allowance’ and pensions worth more than that threshold may be liable to tax at 55% when the saver reaches 75 years of age or dies.

No wonder more people are willing to consider VCTs which, like any other investment trust, aim to diminish the risk inherent in equities by diversification. Like other investment trusts, VCTs are pooled funds whose own shares can be bought and sold on the London Stock Exchange.

This structure enables individual investors to share the cost of professional stock selection and spread their money over several underlying companies. The aim is to reduce individual shareholders’ exposure to the risk of setbacks or failure at any one firm and maximise returns.

There are several types of VCT recognised by the Association of Investment Companies (AIC). Their sector names give a good idea of the underlying assets; VCT AIM Quoted - for companies listed on the Alternative Investment Market; VCT Generalist; VCT Generalist Pre-Qualifying; VCT Specialist: Environmental; VCT Specialist: Healthcare & Biotechnology; VCT Specialist: Healthcare & Biotechnology Pre-Qualifying; VCT Specialist: Media, Leisure & Events; VCT Specialist: Technology.

Investors with personal or professional knowledge in a specialist area may favour one sector over another. In all cases, the maximum VCT investment must not exceed £200,000 a year.

Whichever sector seems suitable for you, if any, it is a good idea to seek professional financial advice specific to your individual circumstances before taking any action. As a general rule, because of the risks involved, VCTs should only comprise a small percentage of a diversified portfolio.