Savers worried about landing a big tax bill on their pension savings have been urged to tax-proof their retirement pots.
The threat of tax raids on pensions looms large for hundreds of thousands of investors, who must quickly find alternative ways to save or face a shock bill.
From April, the total amount that savers can keep in a pension pot tax-free will be reduced from £1.5m to £1.25m.
Immediately, this will drag 30,000 people into paying up to 55pc tax on the excess, according to HM Revenue & Customs figures. The taxman expects this number to balloon to 360,000 as savers’ pension pots grow towards the so-called lifetime allowance threshold.
Experts said someone in their forties with a £300,000 pension pot could easily hit the limit by retirement.
Alistair Hardie of Standard Life said many are sleepwalking towards a trap.
“The stark reality is the reduction in the lifetime allowance is going to affect more people than first realised,” he said. “And it looks as if these people are unaware of the risk of a tax charge. Savers might be years away from retirement but if they have saved a fair amount in various pension funds they could be near the danger zone.”
Many astute savers facing this fate are turning to an alterative tax-efficient investment called venture capital trusts, commonly known as VCTs. After pensions, which offer full tax relief on anything saved, VCTs are one of the best ways to shelter your investments.
Tax relief is paid at 30pc on up to £200,000 saved each year, provided that you keep the investment for five years or more. So someone who puts £10,000 into a VCT will get £3,000 extra as tax relief, with returns free of both capital gains and income tax.
The funds are typically favoured by wealthier savers, as there are larger risks involved, but that should not exclude those with some way before hitting the pension savings limit.
The added danger is due to the funds investing in small businesses seeking capital; while one may become the next Apple, another could fall by the wayside.
At least 70pc of assets in VCTs must be invested in unquoted companies, which are typically worth less than £15m. The remaining 30pc can be invested anywhere, but is often put into cash to stabilise the fund.
Over the past 12 months, more money than ever before flowed into these funds, which now contain £2.9bn belonging to tens of thousands of savers. Experts say they are ideal for retirement savings, as they should be held over the long term.
Ben Yearsley, head of research at Charles Stanley, said: “If you are 40 years old and have amassed a pension pot of £300,000 then you are likely to hit the lifetime allowance by the time you retire, as you would expect your pension pot to double every decade,” he said. “Effectively, to avoid getting taxed there is little alternative but to look around elsewhere to supplement a pension, and VCTs provide similarly generous tax breaks.”
Jason Courage (pictured) has put a portion of his savings in venture capital investments with Puma, one of the main providers.
The 46-year-old property investor, who lives in London, said: “It’s about being clever and tax efficient with your savings. I find VCTs ideal as a side pot to my pension – the capital returns at Puma have been excellent, too.”
The crucial element of any investment is its return. Higher risk often means bigger rewards in the long-term, but not always – so it’s important to pick the right funds.
On average, VCTs have delivered 88pc growth over the past decade, according to the Association of Investment Companies. By contrast, the FTSE All-Share index has grown 65pc. The three best-performing funds since 2003 are British Smaller Companies, up 359pc, Northern Venture Trust, up 297pc, and ProVen Growth and Income, which has grown 226pc. Unlike in an Isa or a self-invested personal pension, any dividend payouts are not automatically compounded on an annual basis. So instead the onus is on you to reinvest the dividends paid to you.
Savers should invest only after exhausting their full Isa allowance for the year, which in 2013-14 is £11,520. And don’t go overboard – the typical VCT only requires a minimum investment of £5,000, so start small. Mr Yearsley said the funds should account for no more than 10pc of a portfolio.
What VCTs do the experts tip?
When choosing a VCT, scrutinise the fund manager’s past performance and how successful the fund has been in taking money out of its investments. This is because unquoted assets are extremely illiquid, meaning it is often difficult to sell your investments quickly.
A number of respected mainstream fund managers also run VCTs, including Giles Hargreave, who manages the Hargreave Hale Aim VCT 1 & 2. It will be seeking new investment in the coming months, and was tipped by a number of brokers. Darius McDermott of Chelsea Financial Services tipped Northern as one of the best specialist VCT providers, praising its “good track record of consistently hitting its dividend targets” and favouring “larger-sized deals and companies, which reduces the risk”.
Mr Yearsley favoured Foresight Solar VCT, which invests in solar panels. He said: “The company promises inflation-linked payments.” Albion Ventures, which runs a number of VCTs, was another favourite for the experts. The company has invested in the likes of City Screen, a cinema chain, which was last year sold to Cineworld.
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