The new pension freedoms, to be introduced from April 2015, herald a new era of flexibility when it comes to deciding how to take your retirement income. However, there are competing restrictions on the amount you can save within pensions each year (the annual allowance) and over your lifetime (the lifetime allowance).
Many clients – particularly those who have made good use of their pension allowances – have faced reduced annual and lifetime pensions allowances that are cutting off the amount they can invest into their pensions.
Because of this, now is the time to be making the case for tax-efficient investments, such as venture capital trusts (VCTs) and enterprise investment schemes (EISs), to be considered as part of an overall retirement planning portfolio, both at the saving and income producing stages.
But before considering how tax-efficient investments could complement existing pension arrangements, let’s make sure that the investment risks are placed in the right context.
Both VCTs and EISs are regarded as high risk. Those that do well have the potential for significant returns, but they don’t all succeed. If you are not comfortable with the idea of investing in smaller companies then such investments might not be right for you.
The performance of such investments can also be more volatile, which means that, over time, their values can fluctuate significantly. When it is time to sell there is a chance that the investment will have reduced in value. There are minimum investment limits and VCTs and EISs certainly won’t be suitable for everyone.
It is also important that the tax benefits aren’t allowed to overshadow the risks, particularly as the tax treatment for investors depends on your own individual circumstances and may be subject to change. In addition, the availability of any tax reliefs also depends on the underlying companies of each product maintaining their qualifying status.
For all these reasons there is no suggestion that VCTs or EISs could – or should – be used to replace pension planning completely. However, such products may have an invaluable role to play as part of a retirement planning portfolio, particularly for investors who have reached, or are coming close to, the limits of a traditional pension investment, and are looking to consider another tax-efficient string to their bow.
As one example, before retirement, a VCT could potentially be used as a long-term investment, with dividends reinvested to help their overall VCT pot grow. What’s more, an investor can keep reinvesting their VCT every five years to continue to benefit from upfront income tax relief, which is up to 30 per cent of the value of the investment. After retirement, the VCT could continue to provide a stream of tax-free dividends to help the investor to supplement their pension income, while the capital stays invested.
While those arriving at retirement might want to diversify their investments, many will still expect a degree of security and a balance of risk and reward. With the right advice, tax-efficient investments that complement pensions could potentially give an added dimension to retirement planning.