For appropriate investors that have available funds left over after fully using this current year’s tax-efficient wrappers, what are some other options to consider?
Those aged 18 or over can put £20,000 into an Individual Savings Account (ISA) each tax year, while £9,000 can be put away on behalf of children. For pensions, the limit is higher and for most is £40,000 each tax year, or 100% of their earnings, whichever is lower. But some people might find they exceed this limit and want to know where to invest next.
Much will depend on the wider circumstances of the individual, as a start, you could consider using the tax allowances of your children/grandchildren, by making gifts to them under the annual exemption or gifts out of normal expenditure rules, which could be exempt from Inheritance Tax (IHT) from day one. Should you have an IHT liability taking this action can reduce the value of your estate, whilst the gifts could fund Lifetime ISA contributions on which for example your children could qualify for a bonus of up to £1,000 per annum towards their first house purchase, or Pension contributions on which tax relief at their marginal rate of Income Tax would be applied. If you would prefer to retain control of your money, there are other options to consider.
If you are prepared to take on higher investment risk, there are two investment vehicles that allow for early-stage investment in high-growth companies while facilitating tax reliefs – Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT). Both provide support to medium-size business (fewer than 250 employees and less than £15m in gross assets) in early stages of development. Both schemes were designed with the intention of directing private risk capital into small UK businesses and helping the British economy grow.
Both offer attractive tax benefits and low correlation to mainstream, large-cap markets (like the FTSE 100), so can be attractive to investors who are looking to reduce tax bills, build diversification into their portfolios and are comfortable with the risks involved.
VCTs and EISs are particularly useful for higher-rate taxpayers looking to reduce their Income Tax bill. They can help investors who want to save for retirement tax-efficiently, but have used all their pension contribution allowances or who may be close to breaching their pensions Lifetime Allowance.
Despite these similarities, they each have some distinct features that may make one more suited than the other for individual investors.
VCT investments carry tax relief to encourage you to invest in smaller, higher risk companies. By pooling your investments with those of other customers, VCTs allow you to spread the risk over a number of small companies. You can invest by subscribing to new shares when a trust is launched or by buying shares from other investors when the trust has been established.
You receive Income Tax relief when you buy newly issued VCTs, currently at the rate of 30% on investments of up to £200,000 per tax year. This relief is provided as a tax credit to set against your total Income Tax liability and, therefore, cannot exceed your total tax liability for the tax year. You do not receive this tax relief if you buy existing Venture Capital Trust shares. The main reason for holding VCTs is though the tax free dividends, which form a significant part of the returns available.
You have to hold shares in a VCT for at least five years to keep the Income Tax relief – if you have to sell them before then, you’ll lose this benefit. You do not pay any Capital Gains Tax on profits from selling your VCT shares, no matter how short a period you have held them provided the company maintains its VCT status.
The EIS is a tax-efficient way to invest in the new shares of small businesses, offering investors who invest for a minimum period of three years benefit from 30% tax relief as well as exemptions from Capital Gains Tax and Inheritance Tax. EISs aim to help unquoted companies not listed on an exchange to attract equity investment by offering investors a range of tax incentives.
There are several ways to invest, either in single companies, or a collective investment such as an EIS fund. There is no minimum amount an investor can invest in any one company. However, any single investor cannot invest more than £1 million a year in total into the EIS. There is a carry back facility where part or all of the EIS investment can be treated as being purchased in the preceding year. Should the value of your EIS investment make a loss, it may be possible to apply for Loss Relief.
Capital Gains Tax is normally charged when certain capital (or ‘chargeable’) assets are sold at a profit. However, deferral relief means it is possible to defer a Capital Gains Tax payment on gains arising on disposals of any assets where these gains are reinvested in new shares in an EIS company. The chargeable Capital Gains Tax is deferred for the life of the investment. You can defer gains made in the 36 months prior to your investment or 12 months after.