How do VCTs and EIS compare for retirement planning?
Philip Cook, private client partner, Thomas Miller Investment
VCTs and EIS complement pensions
VCTs provide tax-free dividends, which makes them attractive for higher-rate taxpayers seeking income in retirement who are willing to lock their money away. Capital at risk is reduced by an income tax deduction of 30% on the amount invested, assuming shares are retained for five years. Therefore, this can make VCTs a good complement to pension income in retirement.
Meanwhile, dividends paid to EIS investors are taxable, so returns are generally distributed as capital that is tax-free. This profile makes them less attractive for investors seeking regular retirement income.
The benefits associated with EIS, including an income tax deduction of 30% of the investment, the opportunity to defer capital gains and benefit from inheritance tax exemption through business property relief (BPR) are attractive for other investors, however.
John Glencross, chief executive, Calculus Capital
Good pension ‘top-up’
With the annual pension contribution limit now at £40,000 – when it was £255,000 only a few years ago – and the lifetime allowance at £1m, there is a clear need among higher earners for supplementary tax-efficient investments through which they can ‘top-up’ their pensions. EIS and VCTs each have attractive characteristics in this respect that make them good complements.
The bulk of VCTs’ investment returns are typically paid as tax-free dividends, which is very useful from a retirement income perspective, particularly because income from pensions is taxed. EIS are 100% free of IHT after two years, which can have an important role in estate planning alongside pensions.
EIS and VCTs can provide portfolio diversification and lower correlation to public markets through exposure to potentially higher growth smaller companies.
Eliot Kaye, investment director, Puma Investments
Both good alternatives
There has been an increasing demand from investors for government-backed tax-efficient products as they look for alternatives following the reduction of the annual pension allowance.
When it comes to choosing between EIS and VCTs for pension planning, while both schemes may appear similar, they typically have very different structures.
VCTs benefit from tax-free dividends while EIS allows for tax benefits on capital gains to be deferred. Most EIS qualifying businesses also qualify for business property relief, which can help investors mitigate IHT.
The key is to consider whether a client wants to receive running income versus capital in retirement, their time horizon approaching and after retirement and their attitude towards risk.
Will Fraser-Allen, deputy managing partner, Albion Ventures
Benefit from pensions freedoms
Both VCT and EIS benefit from an income tax rebate equal to 30% of the initial investment. VCTs pay attractive tax-free dividends which do not have to be included in a tax return. EIS can usually provide capital gains tax deferral, business property relief and also benefit from loss relief.
With the recent significant pension reforms and increasing freedom, VCTs will become increasingly popular as an additional form of pension supplement post-retirement, as well as to working-age professionals who regard it as part of their long-term savings plan.
We have also seen diversification become a retirement watchword and as a result VCTs, particularly generalist VCTs, are becoming an increasingly popular pension supplement, particularly given their ability to deliver a regular tax-free income.
Paul Sheehan, investment manager, WH Ireland
EIS more generous for tax breaks
Retirement planning is increasingly complicated with pensions no longer providing the solution they once did for high net worth investors. I believe the case for investing in EIS for pension planning is strong, where suitable for investors who have taken the appropriate advice, as they can offer a tax-efficient investment structure and offer a more generous set of tax breaks than VCTs.
Some of the main benefits are the larger limit on investment of £1m in an EIS, the holding period to qualify for tax relief, investors in an EIS benefit from 30% income tax relief and CGT deferral is unlimited for EIS, but not via VCTs. Both EIS & VCTs are potentially high risk investments but with an EIS if you sell at a loss you can gain relief against income, not available under VCT rules.
The additional benefit of EIS investments is the IHT mitigation after two years.
Jack Rose, head of tax products, LGBR Capital
It is important to note neither are a substitute for pension contributions. However, as pension contribution levels are becoming more complicated and restrictive, combining with EIS and/or VCT subscriptions can be a complementary solution.
The choice between the three options or a combination really depends on the individual client’s investment needs and objectives. For example, if someone is looking for something akin to a pension with income characteristics then the tax-free dividends offered by VCTs can be very attractive. For those that have either a large CGT liability or are looking at estate and IHT planning, then an EIS can be a useful part of a solution.
Also, an investor who has reached their maximum pension contribution can continue to utilise the subscription-based tax reliefs offered by a VCT and/or EIS.
Tom Hopkins, co-founder, Kin Capital
Benefit dependent on investor
There is no right answer when reviewing EIS versus VCTs when planning for retirement, as it depends on the underlying investor.
For instance, a more elderly investor might be looking for a tax-free income and hence a VCT might be more appropriate. VCTs typically provide annual tax free dividends of between 3%-5% per annum.
For a high earning investor who has reached his pension threshold, and is looking for a growth kicker to his retirement portfolio, EIS could be an appropriate investment to provide the desired return.
Capital gains on EIS investments are tax free and the tax relief results in circa 37.5p per £1 invested at risk, which is attractive when investing in higher-risk growth companies.
Paul Jourdan, CEO, Amati Global Investors
EIS designed for sophisticated investors
The difference between the VCT and EIS schemes can be summarised by saying that the VCT scheme is designed for a very wide market, and therefore is kept very simple for the investor, whereas the EIS scheme has more generous tax reliefs in some respects, but is designed for sophisticated investors, who can handle a fair amount of complexity in their tax affairs.
VCTs are fully listed companies with independent boards of directors, whereas EIS investments are mostly unregulated and place greater emphasis therefore on the investor being able to form their own view of the risks involved.
The origins of the EIS legislation were devised to encourage experienced business people to back young companies as angel investors, whereas VCTs were designed to encourage a broad range of retail investors to invest in such companies collectively.
Jason Hollands, MD business development & communications, Tilney Bestinvest
Features offered very different
Although VCTs and EIS invest in the same universe of underlying companies and both offer highly attractive tax reliefs, they also have key differences.
EIS investments are not income generating, whereas most VCTs have a strategy of maximising return of capital to shareholders through tax-free dividends, which can make VCTs a very attractive component within a retirement income plan alongside a pension.
EIS, however, offer certain features not available through VCTs, namely the ability to defer a capital gains tax liability, loss relief where an EIS flops and exemption from IHT after two years.
We therefore see EIS as having some very useful features for financial planning purposes, including inheritance and estate planning. But for providing a combination of high income and diversification, VCTs would be a more natural supplement to a pension for most investors.
Charles Owen, founder of CoInvestor
EIS growth set to surge
EIS could be a major beneficiary as pension reliefs are cut back. Even if fears regarding pension cut backs prove unfounded, the pensions tax regime is already set to become less generous to those with higher incomes and greater wealth.
These reductions on their own will be enough to prompt many investors to look elsewhere for tax-efficient savings, with EIS likely to be at the top of many people’s lists.
EIS offers generous tax relief for investors backing small unlisted growth companies – either directly, through investments in qualifying companies, or via a professionally run fund.
That makes it a natural fit for pension investors looking for an attractive source of potential growth over the long-term, with tax incentives.
Further changes to pension rules, particularly headline-grabbing measures on upfront tax relief, will ensure that the steadily increasing growth in EIS investing continues.
Paul Latham, managing director, Octopus Investments
A good alternative
For many advisers, both VCTs and EIS offer attractive, complementary tax-efficient investments for clients looking to take advantage of the opportunity to diversify their retirement plans and create a more personalised approach to investing.
We are seeing more interest in VCTs in particular as complementary retirement planning solutions, due to the benefits of being able to access an existing portfolio of companies and receive regular tax-free dividends.
In contrast, EIS products are popular with investors considering estate planning, due to the inheritance tax benefits. As more people start to explore alternative pension planning solutions, there is a growing need to get more people seeking advice tailored to their personal circumstances.
Ben Thompson, director, Foresight Group
In recent years, VCT and EIS have become far more mainstream in investors’ retirement planning.
Several providers have launched EIS funds in recent years that invest in qualifying companies that generate more predictable returns, which have generated considerable appetite from investors, who find the flexibility of the three-year qualifying period combined with the tax reliefs very attractive.
The longer qualifying holding period required for VCTs of five years can be attractive to investors who are also looking to generate income, and several VCTs have been able to offer a good track record of dividend payments, which can of course be taken tax-free.
Given the volatility in the equity markets, this can be very attractive when compared alongside annuity rates and bond yields.