Pensions are still a highly attractive vehicle for long-term saving. You get tax relief on the way in, investments within the wrapper are shielded from tax on capital gains and dividends, and in most cases your pension assets can be passed onto your heirs free of inheritance tax.
Yet for higher earners, pensions are about to get a lot less attractive. From April next year, for every £1 you earn above £150,000, your pensions annual allowance (the amount you can contribute each year without a tax charge, currently £40,000) will fall by 50p. This means that anyone earning over £210,000 will only be able to receive tax relief on pension contributions of up to £10,000 a year. Beware also the definition of earnings in this respect, which has become more complicated.
One consequence is likely to be an increase in the volume of money looking for other tax-efficient homes for long-term savings, notably venture capital trusts (VCTs) and Enterprise Investment Scheme (EIS) investments.
VCTs invest or lend money to small, higher risk businesses. You receive 30 per cent income tax relief on subscriptions to a new VCT (on annual investments of up to £200,000), any dividends received are free of tax, and no capital gains tax is payable when you dispose of it. You do, however, have to hold the investment for five years in order to keep the income tax rebate.
If you buy EIS-eligible shares, 30 per cent of the cost of the shares is offset from your income tax bill, up to a maximum of £300,000, you pay no capital gains tax on disposal, and you can offset the amount of the loss (less the income tax relief) if you lose money from the investment. There are quite complicated rules concerning EIS qualification, however, and you must generally hold the shares for at least three years.
Due to the tax incentives and the range of investments that can be held within them, pensions should still be the first port of call for anyone seeking a home for long-term savings. But once you’ve used up your annual (or indeed lifetime) allowance, how can you decide whether VCTs and EIS are right for you?
First, be aware that these are only for people willing to take substantial investment risk. The government has explicitly designed VCT and EIS tax incentives to drive investment into smaller, higher risk companies with a focus on growth, and has regularly tightened the eligibility criteria in order to exclude lower risk capital preservation schemes.
Second, while there is plenty of information online about these schemes, it is essential to consult a regulated adviser or wealth manager before investing any money. Not only are the rules governing eligible investments sometimes opaque, but the tax relief itself is not always straightforward. A regulated adviser should use third party research companies to conduct due diligence on the schemes, and will also help you to avoid duplicating investments in underlying businesses.
Ultimately, it’s important that investors ensure that their income in retirement comes from a range of different vehicles. Even those who have relied on pensions for their whole income, for example, have been buffeted by regular policy changes (and there are likely to be more to come). Buy-to-let (impending changes to taxation notwithstanding), a taxable investment portfolio (which will benefit from the £5,000 tax free dividend allowance from April 2016), and, arguably, VCTs and EIS investments should all be part of the mix.
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