If you are a high earner, it is likely that you are frustrated by the lack of tax avoidance now available to you. If you earn over £360,000 you are limited to a net contribution of £8,000 per year to a pension, which is income tax relief from the government of £4,500. You have £20,000 that you can add to an ISA each year and that is largely it.
Between £260,000 and £360,000 you gradually lose your ability to pension, with the limit dropping from £60,000 a year to £10,000.
You can add a further £10,000 per year to a general investment account to build up a fund but seven or so years you will have a fund that uses your capital gains tax allowance of £3,000. In reality you are not really avoiding tax as using an allowance.
Saving £10,000 (including the relief element that added is added to the pension) a year is not going to accrue to enough to live on later in life.
There is another tax relief that is much more generous but is not without its problems. You can also contribute £200,000 per year into Venture Capital Trusts (VCT). You receive 30% of your initial investment back as income tax relief in your tax return. In addition, income from a VCT is tax-free and income levels are higher.
Any tax breaks this generous has a trade-off and, in this case, you are helping to support small UK businesses. The government uses this tax incentive to funnel money into the sector. An ordinary investor would have a low allocation to UK companies because they now make up less than 4% of global stockmarkets and so this might be a considerable shift from the normal investment strategy. In addition, investments in this size of company are very risky and losses are to be expected.
Historically VCTs have offered high levels of income but if the income isn’t retained or reinvested, the capital value has tended to fall over time. Investing in a range of VCTs can offer some diversification of risk but ultimately you are diversifying in a small pool of companies.
The last issue with VCTs is that they are not bought and sold like ordinary listed company shares and are therefore difficult to sell if you need the money back. You can sometimes sell them back to the VCT manager but there are few other options. This makes sense as why would you buy a second-hand VCT which doesn’t come with the 30% income tax relief, when you can just buy a new one.
So VCTs can be right for clients with very high-income tax bills, who have maxed out every other investment allowance available and either have ahigh appetite for risk or have some specialist knowledge in the sectors being invested into.