Venture capital trusts are becoming a popular investment among pension savers, writes Stuart Lewis.
Pensions are still one of the most tax-efficient investments out there – and they remain the go-to retirement planning tool for most people. But recent reforms to pensions have meant some people have been looking at a broader approach to retirement planning.
Since 2016, a tapered annual contribution limit has been introduced, ranging from £40,000 (the upper limit) to as little as £10,000 for those who earn £210,000 or more.
Last April, the lifetime allowance (LTA) was reduced from £1.25m to £1m. Should the pension exceed the LTA, not only will valuable pension tax relief be lost but there will also be a hefty charge of up to 55% on the excess withdrawn.
For anyone who started their pension early, there is a good chance they could end up over the LTA before hitting retirement age. In fact, the lower LTA is expected to affect up to 55,000 individuals in 2017.
These changes in regulations are certainly a key factor behind the upsurge in demand for venture capital trusts (VCTs). They are increasingly seen as a viable and mainstream option for clients who are both comfortable with the risks of investing in smaller companies and are looking to complement and diversify existing retirement arrangements.
VCTs offer up to 30% upfront income tax relief providing that shares are held for at least five years, as well as tax-free dividends and tax-free growth.
Data from the Association of Investment Companies show the sector raised £542m in 2016-17 – the second highest amount raised and an 18% increase on the previous year’s figure (£458m). The data also shows that VCT assets under management to 5 April 2017 (£3.9bn) are also up on the previous year’s £3.6bn.
It’s not just the tax benefits that are attractive to investors looking to diversify their retirement planning portfolio. For many VCT investors, there is the feel-good factor of sharing in the growth potential of fast-growing, British companies and supporting the growth of the UK economy alongside planning for their own futures.
But VCTs come in all sorts of shapes and sizes. All VCTs are listed companies in their own right and many seek to offer regular dividends as well as the potential for special dividends.
While some choose to invest in specialist niche sectors, other, larger VCTs make a virtue of the fact that holding more portfolio companies offers greater diversification.
Some high-profile examples of companies that have benefited from VCT investment include Zoopla Property Group, Secret Escapes, Graze.com and LoveFilm (now Amazon Video).
Demand vs supply
Recent legislation changes included the stipulation that funds raised by VCTs can no longer be used for company acquisitions or management buy-outs. In some respects, the rules have been changed to make sure that VCTs focus on funding those companies that need it most.
Some VCTs have had to restrict raising new funds while they look at adjusting their operating models. But for those VCTs that already operate at the early-stage end of the market, it remains business as usual.
The combination of increased investor demand for VCTs and some VCTs restricting their fundraising led to many VCTs closing early this year.
Octopus Titan VCT closed before tax year end despite raising a record £120m – the largest ever fundraise for the UK’s biggest VCT.
For those people seeking to invest in VCTs as part of a diversified retirement strategy, taking advice early could help to ensure they are able to identify and invest in their VCT of choice as demand continues to grow.
As the regulatory world changes, so too does the most appropriate way to plan for retirement. It would be hard to underestimate the impact of seeking professional advice to help people make the most of their hard earned money, understand their options for retirement in an increasingly complex investment environment, and make their money work as hard as possible for them to enable them to enjoy their later years.
Stuart Lewis is head of tax-efficient investments at Octopus Investments