Pre & post retirement planning complementary solutions
With the annual pension contribution limit now at £40,000 – when it was £255,000 only a few years ago – and the lifetime allowance at £1m, there is a clear need among higher earners for supplementary tax-efficient investments through which they can ‘top-up’ their pensions.
BUILDING THE ‘RETIREMENT POT’
EIS and VCTs each have attractive tax planning characteristics which make them good investment options as both benefit from an Income Tax rebate equal to 30% of the initial investment. An investor who has reached their maximum pension contribution can continue to utilise these subscription-based tax relief solutions.
While pension investments are largely subject to income tax as they are drawn down, VCT and EIS solutions are not. Whilst VCT and EIS investments must be held for a fixed period to qualify for tax relief, after the holding period investors have a great deal of flexibility and greater access to the investment, compared to pensions.
For some investors, the situation deteriorates further where their employer used to give them significant pension contributions but can no longer because the investor has either reached their lifetime limit or have contributions capped at £10,000 per annum. Example: an investor used to receive a contribution to their pension from their company of £50,000 per annum but can now only contribute £10,000 per annum meaning that the investor’s remuneration package has decreased. Asking the employer to pay a net £40,000 to the employee would balance their package and they could invest this into an EIS. The investor’s net position (after tax relief) would be almost the same as when their employer contributed more pension.
The bulk of VCTs’ investment returns are typically paid as tax-free dividends, which is very useful from a retirement income perspective but perhaps not so useful for pre-retirement pot building.
EIS are 100% free of IHT after two years, which can have an important role in estate planning alongside pensions and can also benefit from loss relief.
EIS and VCTs can provide portfolio diversification and lower correlation to public markets through exposure to potentially higher growth smaller companies.
Several providers have launched EIS funds in recent years that invest in qualifying companies that generate more predictable returns such as the Evolve Asset-Focused EIS Portfolio which allows clients to access asset-backed trading activities that provide a degree of capital preservation and risk mitigation.
POST RETIREMENT ‘THE ELIMINATION OF INCOME TAX IN RETIREMENT’
Consider a retired man with a pension generating an income of £50,000 per annum on which he pays £8,700 of income tax plus further Income Tax on savings and share dividends resulting in a total tax bill of £9,000. He has investable assets of £150,000.
Investing £30,000 into an EIS will give the investor Income Tax relief of £9,000. This will wipe out his entire Income Tax bill for that year. In the following year, he can invest a further £30,000 with the same result and again in year three – assuming his income tax bill does not change and, of course, assuming current EIS legislation is unaltered.
An EIS can return the investor’s capital after it has been held for the three-year qualifying period. This means the year one investment, having reached the three-year qualifying period by year four, can, once the fund has been liquidated, be reinvested into another EIS to eliminate the investor’s year four income tax bill.
Similarly, the year two EIS investment can be reinvested in year five, year three into year six and so on. It should be noted, however, that there is likely to be a period after the three year EIS qualification period while the EIS fund is wound up. Therefore, investors following this approach over an extended period may miss a year as their investment date moves later each tax year.
However, under current legislation, EIS allows investors to reclaim income tax from the previous year as well as the current year; thus, the delay could be addressed through taking this option. Alternatively, investors could view the EIS as a four-year cycle.
A similar principle can of course apply to VCTs, albeit you are then looking at a five-year cycle.
VCTs and EISs are the complement of choice for many investors and it is easy to see why. The tax relief alone can provide a reliable return; plus, investors are able to access their money after the tax qualification periods to either reinvest in tax-efficient investments for another round of tax relief, or invest elsewhere.
CAPITAL AT RISK
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