VCTs: Alternative savings vehicle for retirement planning

Many pension specialists thought George Osborne had his eyes on higher-rate tax relief for pension savers. However, the Chancellor has now confirmed that he is not implementing any further changes to pensions in this budget, but even before the budget, the pensions system has come under attack. He has unveiled swingeing cuts to the annual allowance for high earners (an allowance already reduced in recent years) as well as a reduction in the lifetime allowance to £1m.

These changes mean many advisers are now looking for alternative savings vehicles for their clients’ retirement planning – not to replace private pensions, but to run alongside them as clients begin to worry about falling foul of the lower contribution limits. Tax-advantaged alternatives are in relatively short supply, but venture capital trusts (VCTs) are one important possibility.

VCTs are closed-ended funds that build portfolios of small unquoted companies. To be a suitable holding for a VCT, a company must not have assets worth more than £15m and must have fewer than 250 employees (as well as meeting a number of other more technical criteria). Such businesses are more risky than equity investments in larger, more established companies, but in return for the additional risk, investors get a number of generous tax breaks – in fact, significantly more generous reliefs than are available on private pensions.

For one thing, the annual contribution limit to VCTs, at £200,000 is significantly higher. VCT investors get upfront income tax relief of 30 per cent on subscriptions to new fund-raisings – while this is lower than the higher-rate relief paid on pensions, it’s available on the full £200,000 allowance, as long as the investor has enough income tax liability to offset. Also, investments in VCTs grow free of income tax on dividends and capital gains tax on profits. That applies however large the investor’s portfolio is – there is no equivalent of the lifetime allowance.

These incentives are attractive, but the underlying investment still has to be right for the client, of course. For many investors, however, the appeal of a VCT is its long-term exposure to companies with the potential to grow rapidly – and that sits very well with the goal of retirement savings. VCT investors should expect to see some blow-ups in their fund’s portfolios, but many existing funds now have good long-term performance track records.

For all these reasons, many advisers believe VCTs have a bright future as a way to save additional sums for retirement. Think of a waterfall effect – once the client’s pension is full, income cascades down into additional receptacles that also provide tax incentives for long-term savings. Even if the budget makes no further changes to pension tax allowances, that principle will still apply.

VCT managers themselves anticipate getting a boost from changes to the pension tax rules – many are already reporting additional interest from investors. In a recent survey published by the AIC, two-thirds of VCT managers said changes to the pension rules were a reason for them to be optimistic about the year ahead.