Have you used up your pension allowance or are you looking to diversify your portfolio?
If so, it could be the time to think about diversifying investment from more traditional and low risk forms of investment into more risky investments such as Venture Capital Trust (VCT) funds.
Here we outline why.
Reasons to Invest In VCTs
Most investors cannot access venture capital through pension plans and could be missing out on higher returns, as venture capital is almost as good as bonds, when compared with equities, in regards to diversification.
As well as improving diversification, investing in VCTs could generate tax-free income and provide another way to invest tax-efficiently for retirement.
What are VCTs?
Let’s take a more detailed look at VCTs which are listed companies that invest in a diversified portfolio of unquoted or AIM-listed companies in the early stages of their growth. The AIM (Alternative Investment Market) is a specialized unit of the London Stock Exchange (LSE) catering to smaller, more risky companies.
Though riskier these small, early-stage companies can be flexible and adapt quickly to shocks, such as a global pandemic – and we all know the effects of that!
Compared to larger companies, they are often able to adapt more quickly and exploit new opportunities. There are certainly some exciting, innovative businesses in VCT portfolios today.
Tax benefits
Attractive tax reliefs are available to compensate for some of the risks of VCTs which include income tax relief and tax-free dividends.
For example you can claim up to 30% in income tax relief on a VCT investment, provided you hold your investment for five years. This means that for a £10,000 investment you could claim £3,000 off your income tax bill.
VCTs are recommended for investors looking for a long term investment of 5 years or more in order to keep the tax relief.
Most VCTs will target a yield of around 5% a year. This yield is expressed as a percentage of the net asset value (NAV) of the VCT and is a measure of the value of the companies in which a VCT invests. For example, a £10,000 VCT investment which paid out a 5% dividend, would deliver an annual income of £500.
A VCT invests in early-stage businesses and support them in their growth. While some businesses will fail, others may become household names. When these successful companies are ready for the next stage of their growth, the VCT will look to sell their stake in that business. This creates a return which the VCT can then distribute as tax-free income to its shareholders.
What are the risks?
It’s important to understand the risks before deciding to invest. The value of an investment and income from it can fall as well as rise and you may not get back the full amount you invest.
VCT shares can be volatile, meaning their value may fall or rise more than shares of companies listed on the main market of the London Stock Exchange. They may also be harder to sell.
Tax reliefs also depends on individual circumstances and may change in the future and being able to successfully claim tax reliefs depends on the VCT maintaining its VCT-qualifying status.
VCTs are inherently different to pensions and ISAs and shouldn’t be compared on tax benefits alone. However, where an investor has built up significant pension and ISA investments, a VCT could be considered as part of a tax-efficient portfolio for retirement.
Venture Capital investment should be built up alongside pensions, not after they are full.
To find out if VCT investment will work for you please talk to one of our pension experts.