EIS vs VCTs – what’s the best option for retirement planning?
Pensions are the most common form of investment for helping achieve financial stability in retirement. However, while they may be the obvious go-to option, there are other forms of investments out there that are tax-efficient and can supplement routine pension planning.
Take Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs), for instance, both are commonly-used alternatives to pension schemes which can generate considerable tax savings.
Let’s take a look at EIS and VCT, two different options, which are among the Government’s most popular venture capital schemes, in a bit more detail….
What is EIS?
It’s a Government scheme aimed at helping smaller, higher-risk trading businesses generate finance by enabling them to offer a range of tax relief to investors, who purchase company shares.
What are the benefits of going down the EIS route?
EIS offers greater investment protection an extensive selection of tax reliefs – Income Tax Relief, Capital Gains Tax (CGT) Relief and Loss Relief. But what’s most attractive about it is that you can benefit from multiple tax advantages from a single investment, not just one per investment.
Furthermore, it’s possible to offset a capital loss against an individual’s taxable income, regardless of whether or not the rest of their EIS portfolio is in profit. The tax relief resulting in circa 38.5p per £1 being invested ‘at risk’, making EIS much more of an attractive option when investing in higher-risk growth companies. Meanwhile, any capital gains on EIS investments are tax-free.
Why the EIS benefits can significantly outweigh the ‘risks’
The ability to offset any losses against CGT and income tax, which we mentioned above, is where EISs really come into their own. For instance, if you were to invest £20,000, you would receive £6,000 in Income Tax Relief. If the investment went bust, you could lose £14,000, the net outlay after the Income Tax Relief. However, as a 40% taxpayer you would still be eligible to claim loss relief of £5,600, equating to 40% of £14,000 of the net loss, with 45% taxpayers claiming £6,300.
Even in the worst-case scenarios, higher and additional-rate taxpayers would receive total tax reliefs of £11,600 and £12,300, respectively, on their original £20,000 EIS investment.
What are VCTs?
They’re listed companies that are run by a fund manager and mainly invest in smaller companies that aren’t quoted on stock exchanges. The rules were altered in late 2015, VCTs established prior to this date could invest in more established businesses, but VCTs created more recently can only invest in similar businesses to EIS funds
What are the benefits of VCT investments?
Generally speaking, VCTs tend to provide annual tax-free dividends of between 3% and 5% a year. Alongside this VCT investors can benefit from several income and Capital Gains Tax reliefs, which include not paying income tax on the dividends from their VCT shares or CGT on the growth of them.
They can also benefit from income tax relief on their initial VCT share investment, providing they’ve held their shares for a certain period of time. (However, word of warning – if the VCT doesn’t comply with certain conditions, both the VCT and the investors can stand to lose all of the tax benefits!).
A final note on EIS investments and VCT…
Although VCTs and EIS are eligible for 30% Income Tax Relief, investors have to have held a VCT for five years to be eligible, as opposed to only three years with EIS. In addition to this, EIS investments can be carried back to the previous tax year, whereas VCT’s cannot.
EIS investments are the ideal option for investors who’ve used up their lifetime and annual pension allowances and annual ISA allowances. What’s more, the introduction of the Government’s new EIS Fund structure from April next year will also mean that investors’ effective date for EIS Income Tax Relief claims will be the date the fund closed, rather than the date it makes an investment. For instance, it’s possible that an investment could be made that closes on 5 April 2022 and relief could be carried back to the 2020/21 tax year.
There are clearly pros and cons to both routes, and we’ve only skimmed the surface in terms of what’s possible.
For more details, contact us on 0121 710 1990 or enquiries@midven.com. In the meantime, if you’re particularly interested in EIS investment, take a look at this page where you’ll find details about the Greater Birmingham EIS Fund – https://midven.co.uk/funds/greaterbirmingham-eis-fund/
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