Help: I’ve used my £4,000 pension allowance, but have more to invest. What should I do?

The Problem

With an income of well over £150,000, Rina is an “additional-rate” taxpayer, paying a top tax rate of 45%. She has already used her Individual Savings Account (ISA) allowance (£20,000 for 2021/22). Because she is a high earner she has a reduced (“tapered”) annual pension allowance of £4,000, rather than the usual £40,000. She has also used this fully. Having recently become a partner of a law firm, she has capital available to invest now, as well as the prospect of continued high income in the years ahead. Rina wants to improve her long-term tax-efficient investment planning. She has the appetite to take on higher-risk investments and is happy to invest long term.

Cazenove Capital’s solution

Having considered Rina’s overall asset allocation within her portfolios and her wider wealth, we advised her to invest £100,000 into Venture Capital Trusts (VCTs) and £60,000 into Enterprise Investment Schemes (EIS), each year for five years. EISs and VCTs provide finance for early-stage, unquoted trading companies, by offering a range of attractive tax reliefs for investors who purchase new shares in the underlying companies. These are higher-risk and illiquid investments, so are not suitable for all investors and should be part of a wider wealth management strategy. Rina currently has minimal exposure to these types of assets.

The maximum annual investment into EISs is £1,000,000 for the 2021/22 tax year, with a further £1,000,000 if invested into “knowledge-intensive” companies. VCTs have an annual maximum of £200,000.

These investments offer a 30% income tax relief on the amount invested, providing they are held for the required period (see below for how this works in practice). VCTs must be held for five years, and EISs for three years. VCTs have the added benefit of providing tax-free income via dividends. Any growth is free of capital gains tax for both VCTs and EISs. EISs are also exempt from inheritance tax if held for two years prior, and still held, on death.

We recommended that the annual £160,000 investment be repeated for five years, allowing Rina to build an exposure of £800,000 to a wide range of underlying companies across a range of “vintages” to diversify her investment portfolio further.

In this scenario – by investing £160,000 a year over five years – Rina would cut her potential income tax liability by a total £240,000.

We recommend that she continues to utilise her ISA and pension allowances fully.

How this works in practice

Rina’s wealth planner selects a suitable EIS and VCT manager from our approved panel of providers. Rina then transfers the £100,000 and the £60,000 to her investment manager who liaises with the EIS and VCT providers on her behalf.

Once transferred, the funds are invested in the VCT. For the EIS, funds are drip-fed into a series of qualifying companies which are identified by the EIS manager as attractive opportunities.

When an EIS investment is made, Rina will receive an EIS3 Certificate from the EIS manager with the investment details she must enter on her tax return. Rina will then receive a reduction to her income tax bill, or if she has already paid the tax, the excess will be repaid by HMRC.

The details of VCT investments are also entered in Rina’s tax return and the tax reduction is applied in the same manner. While the tax certificates for VCTs are not required as evidence, it is recommended that these are kept safe.

Therefore, each £100,000 VCT investment would reduce her income tax by £30,000, and each £60,000 EIS investment would reduce her income tax by £18,000 – a total of £48,000 of income tax reduction each year. Over a five year period, this could reduce her tax liability by £240,000.

Care is required when considering these types of investments, firstly from an appropriate investment perspective and secondly from a tax planning perspective, as tax can only be reclaimed if it has been accrued in the first place. No tax will be rebated if there is not a tax bill to offset against.

Shares in EIS companies are likely to be higher risk. Investment in EIS may not be suitable for all investors and you should only invest if you understand the nature of and risks inherent in such an investment and, if in doubt, you should seek professional advice before effecting any such investment.

"Investments made in VCTs will normally be in companies whose securities are not publicly traded or freely marketable and may therefore be difficult to realise and investments in such companies are substantially riskier than those in larger companies.

Investment in VCTs may not be suitable for all investors and you should only invest if you understand the nature of and risks inherent in such an investment and, if in doubt, you should seek professional advice before effecting any such investment."

For information purposes only and nothing in this article/on this slide should be deemed to constitute the provision of financial, investment or other professional advice in any way. You should seek professional advice for your individual circumstances.