Ripping up the retirement planning handbook – Part 5

Venture capital in place of pensions?

From 6 April, you might be faced with making significantly lower levels of pension contributions. If your total income exceeds £210,000 this could be as little as £10,000 in each tax year. You may even have stopped paying in, if your fund is above the lifetime allowance (currently £1.25m but reducing to £1m, also from April).

So what are the alternatives and do they have similar tax breaks?

ISAs (Individual Savings Accounts) will be the first stop for many. There’s no upfront tax relief but you can draw out all of your funds, tax free, at any time. You can invest up to £15,240 each year and there are a wide range of investments available.

But if you want income tax relief, there are other options:

VCTs, EIS and Seed EIS

Venture Capital Trusts and Enterprise Investment Schemes offer a range of tax reliefs by encouraging investment into higher risk small ‘unquoted’ companies. VCTs and EIS are set to become an increasingly popular pension replacement with both offering 30% income tax relief on your investment. The recent Budget announced that Entrepreneurs Relief will be extended to investments in unquoted companies. This will reduce the Capital Gains Tax rate to 10%, brightening the spotlight on VCTs and EIS.

But before jumping in, ask yourself if your retirement planning should be dependent on investing in small unquoted companies?

VCTs

Previous mis-selling scandals have shown that focussing on tax relief can distract us from assessing the underlying quality of the investments and the associated fees charged. According to the latest VCT industry report, the average initial charge is 4.5% and the average ongoing annual management charge around 2%. Over a specified return, performance fees of 10% – 30% could be added; so total annual charges of 2.5% – 3% are entirely possible.

VCT managers like to quote their investment performance including the 30% income tax relief. However, this has two flaws. Firstly, the 30% is given as a 30p tax credit for each £1 invested. This credit is then used to reduce your overall tax liability in the year of investment. But the VCT manager has actually had your £1 to invest, not 70p, making the returns less appealing.

Secondly, the average return of the VCT Generalist sector compared to that of a quoted index of UK smaller companies, shows significant underperformance over 5 and 10 years. Even if you offset the 30p credit against your tax bill, the average return of the VCT Generalist sector still underperforms! Why take the extra risk of investing in small unquoted companies when you could get better returns by simply tracking an index of quoted and more liquid, UK smaller companies?

EIS

Assessing the returns of EIS and Seed EIS is much more difficult, as they are often investments in single unquoted companies. But it’s not unreasonable to assume that investors’ experiences could well be similar to those of VCTs, which at least have the advantage of diversifying some of the risks. EIS, and its little brother, Seed EIS (investment in early stage companies), should really be left to entrepreneurs and business angels who want to provide venture capital, structured in a tax efficient manner.

Replacing your pension provision with venture capital really could be something ventured and nothing gained. You would be taking higher risks by investing into assets which you’d not normally own only for the tax reliefs available.

Our advice is to fund your retirement using a sensibly diversified portfolio of assets, investing into bonds, property and companies of all sizes, and paying some tax on the profits you make.

Let’s talk: jonathane@cooperparry.com