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Alternative to an Isa

I am a 35-year-old bach-elor who has recently inherited just under

£150,000. I am in a professional occupation and have recently

started to achieve my full earnings potential, which means that I now

have surplus monthly income. I have used the inheritance to repay my

mortgage and upgrade my car. This has left me with just under

£20,000 in a high-interest instant-access building society

account. I have no other savings, investments or debts. I want to

invest the £20,000 in a more appropriate investment environment

utilising my Isa allowances where appropriate. I am interested in

very speculative investment opportunities such as smaller com-panies

funds, where I appreciate that the potential for gains is good but

that the potential for losses is high. How would you advise me to

proceed?

The investment areas you are considering can be very volatile and

should be considered long term. If the need arises to access your

investment in the early years, it could prove very detrimental and,

therefore, any investment in this environment should be capital that

you can afford to leave well alone and, more important, that you can

afford to lose.

The first thing I would advise is not to invest all your capital.

Everyone should retain a portion of their funds in an easy access

deposit account to cover unforeseen eventualities and short-term

spending requirements. The amount that should be retained on deposit

varies from person to person but I would suggest that £5,000 to

£10,000 be considered.

There are a number of smaller companies funds which could be suitable

for the balance of your capital. Like many investors, you may believe

that utilising the full £7,000 Isa allowance in the current tax

year is the most appropriate step. It goes without saying that the

less tax you have to pay on your investments, the faster they will

accumulate. Tax avoidance measures are important, especially for

higher-rate taxpayers.

Gains will be tax-free without utilising your annual capital gains

tax exemption, dividend income will be free of income tax and the tax

credit on any dividends received before April 2004 can be reclaimed.

However, given your investment objectives and risk profile, I feel

that there is an even better alternative.

Venture capital trusts seem to be a very well kept secret but would

meet your objectives and be more tax-efficient than an investment

utilising your stocks and shares Isa allowance. VCTs offer

individuals almost identical tax advantages as an Isa (no capital

gains tax on eventual sale and no income tax on dividends) but have

significant additional advantages. The most important from your

perspective is the income tax relief on initial investment. For every

£1,000 you invest in a VCT, the Inland Revenue will reduce your

income tax liability by £200. This is only repayable if you

encash the investment in the first three years.

A VCT can retain a portion of its funds in low-risk investments but

ultimately the majority of it will be invested in unquoted or

Aim-quoted companies that have prospects for significant growth. In

theory, the degree of risk within a VCT which only invests in

Aim-listed securities is lower as there is a formalised market for

the underlying company shares. An Aim-based VCT managed by a

reputable manager seems to offer an extremely tax-efficient way for

you to expose the desired portion of your capital to a portfolio of

investments in smaller companies.

My preferred Aim-based VCT offering at present is Phoenix VCT from

Octopus Asset Management. It will invest in a diversified portfolio

of established Aim-listed UK smaller companies and will be managed by

some of the most successful smaller company fund managers in the UK.

Your investment will leave your Isa allowance intact and it would be

prudent to transfer £3,000 of your retained deposit capital into

a mini cash Isa for the current and possibly the next tax year.

Competitive interest rates are available, access need not be lost but

no tax will be payable on the income.

Assuming the interest rate achieved is the same as the non-Isa

deposit account, the effect of the tax relief to a higher-rate

taxpayer is an increase of 66.66 per cent on the after-tax income

received on this portion of deposit capital.

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