At or Approaching Your Annual Pension Allowance? Your Options…
Since the sharp reduction in the annual allowance from £255,000 to £40,000 today, plus the introduction of the tapered annual allowance, many clients are coming to us having butted up against this contribution ceiling wondering if there’s anything they can do to maximise saving.
If you’ve already made maximum use of available carry forward from previous tax years, then you may want to consider other tax-efficient investment options to continue building up your retirement nest egg.
The most common options are:
Individual Savings Accounts (ISAs)
With an ISA you can invest in cash or investment funds. You pay into an ISA from post-tax income so there’s no tax on withdrawals. There’s also no tax to pay on any subsequent capital gains or dividends you might receive.
You can pay up to £20,000 per year into an ISA and can hold more than one account (e.g. one cash ISA and one stocks and shares ISA), so long as you don’t contribute more than £20,000 across your accounts.
Venture Capital Trust (VCT)
A Venture Capital Trust (VCT) is a company which invests in very small, startup companies with shares traded on the stock market.
Given the companies you invest in are fledgling businesses, not all of them will succeed so there’s a possibility of a company or companies you put money into failing and you getting back less than you invested.
VCT shares can also be hard to sell, so you may not be able to liquidate them quickly if required.
Tax relief on VCTs
VCT investors receive notable tax benefits in the form of income tax relief at 30% on annual contributions of up to £200,000. That means, for example, that if you invest £100,000, you’ll get £30,000 back from the taxman. Note that you only get to keep this tax rebate if you hold your VCT shares for at least 5 years.
There is also no tax on gains, regardless of how long you hold the VCT, as well as no income tax to pay on dividends.
As a result, VCTs may seem more attractive to high earners given today’s reduced dividend allowance, which means that those receiving more than £2,000 in dividend income outside an ISA now pay more tax.
However, despite all the tax benefits of VCTs, they will only be suitable for a minority of investors due to the risks involved, so always get professional advice before you invest.
Enterprise Investment Scheme (EIS)
The EIS was launched in 1994 to encourage people to invest in small companies. Investors who put cash into small, unquoted companies through an Enterprise Investment Scheme can enjoy several tax incentives.
When you make your initial investment, which you usually make directly in a qualifying company, you receive income tax relief at 30% of the cost of the shares. For example, if you invest £10,000, you can reduce your income tax by £3,000 that year. You can also “carry back” this relief to help reduce your income tax liability in the previous year.
There’s also no capital gains tax to pay on any profits you make from an EIS investment. If your investment performs badly and you make a loss, you can offset that loss against income tax. You must hold EIS investments for a minimum of 3 years in order to qualify for this capital gains and income tax relief.
You will, however, have to pay tax on any dividends you receive.
The maximum amount you can invest in any one company is £1m, and there is no minimum. EISs are generally long-term investments, so won’t be suitable if you need ready access to your money or cannot afford to tie it up for an extended period of time.
EIS investments are protected from inheritance tax providing you’ve held them for at least 2 years at the date of your death.
As with VCTs, an EIS is a high-risk investment that can be difficult to sell. It’s unlikely to be suitable for those with low risk appetite or those who may need ready access to their funds.
Seed Enterprise Investment Scheme (SEIS)
Seed Enterprise Investment Schemes (SEIS) were introduced in 2012. They work in a similar way to EIS, except you invest in even smaller start-up companies. These are particularly high-risk, so investors are offered even more generous tax breaks.
You’ll get income tax relief at 50% rather than 30%, so for every £10,000 you invest, you can deduct £5,000 off your income tax bill. There is no capital gains tax to pay and, as with EIS, you can offset any losses against tax as well.
There are other capital gains tax benefits too. If you’ve recently had to pay capital gains tax on another investment, you can reclaim up to 50% of this tax as long as you reinvest the money into SEIS.
The maximum you can invest though SEIS in any one tax year is £100,000.
These investments are even higher risk than VCTs and Enterprise Investment Schemes, so are only suitable for a minority of people. Discuss such investments with your adviser before going ahead and only after other forms of tax-efficient investments have been looked into.