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‘Exasperating’ annual allowance is driving high-risk pension alternatives

Pensions-savings-retirement-piggy bank

Scrapping the “exasperating” annual allowance could stop clients seeking out high-risk pension alternatives that advisers warn are in danger of being missold.

Thameside Financial Planning director Tom Kean says wealthy clients who have reached their annual allowance cap are increasingly looking for pension alternatives and finding tax-efficient venture capital trusts and enterprise investment schemes attractive.

He says clients are “exasperated” by the allowance, a feeling that is only slightly mitigated by clients’ ability to carry forward an unused allowance from pension input periods ending in the three previous tax years to the current period.

Kean says: “The search for alternatives is inexorably leading people towards the arguably more risky world of VCTs and EISs, with both attracting very attractive and plausible-sounding tax reliefs.”

Tax trade-offs

In a recent Money Marketing article, Threesixty managing director Phil Young also warned of the risks around VCTs and EISs and reminded advisers of the suitability requirements, the need for up-to-date continuing professional development, and thorough professional indemnity cover.

Investors get income tax relief when they buy newly issued shares in VCTs. The tax relief is at a rate of 30 per cent on investments of up to £200,000 per tax year and is provided as a tax credit to set against the investor’s total income tax liability. The relief is not available if investors buy existing VCT shares.

Shares must be held for at least five years to keep the income tax relief. Investors will not pay any capital gains tax on profits from selling their VCT shares.

Income tax relief of 30 per cent is also available on EISs which can be claimed up to a maximum of £1m invested, giving a maximum tax reduction in any one year of £300,000. The shares must be held for a certain amount of time, usually three years, or income tax relief will be withdrawn. CGT is also available for EIS investors.

However, Kean is concerned about a misselling risk with these products, given their high risk-profile.

He says: “People need an incentive to save long-term. Wealthy people are generally well-placed to take more risk. And yet with the continued lowering of the input/output bar with pensions, there is a real danger of misselling with ‘normal investors’ effectively being forced into the wrong products.”

Kean adds: “Get rid of the lifetime and tapered annual allowances and in one fell swoop you’ve mitigated a large chunk of risk for unwitting investors.”

Investors are attracted to VCTs and EISs for tax-planning purposes because they offer income tax and capital gains tax relief. However, advisers remain wary of these investments.

Kean says: “The clue is in the tax relief on offer; it’s there to reward people for taking extra risk. And this risk comes in more than one flavour, of course. There is the underlying investment risk with most of these funds.

“But you also have the risk that HM Revenue and Customs start looking closer at the level of take up and consequence cost to the Exchequer.”

“Lightyears” apart

Worldwide Financial Planning IFA Nick McBreen calls the risk-profile contrast between a Sipp and an EIS or VCT “lightyears” apart.

He says: “I have come across people who were funding into a VCT and then taking withdrawals out then into the next tax year to start making pension contributions. Those vehicles are really complex and they are not something for the average person.”

He says advisers have got several “boxes” they should be filling.

McBreen says: “One is your straight-forward pension fund, whether it is occupational or private, the second fund you should be filling is your Isa, the third fund you should be filling is your general investment account or your personal portfolio up to a level where you can manage it for capital gains tax withdrawals, and then above that you should be looking at offshore bonds.”

Rowley Turton  chartered financial planner Scott Gallacher says most of his clients are at retirement age so he has not noticed an uptick in clients wanting to invest in pension alternatives.

But he says: “We did have one enquiry from someone the other day on a VCT case but they had already decided what they wanted to do, which is not a good start because an insistent client or execution-only on VCT is not where we want to get involved.”

Informed Choice managing director Martin Bamford also says most of his clients are at retirement age but there are a few working age clients who are restricted by the taper on the annual allowance.

He says: “The main clients who are finding themselves in that position, being limited on pension contributions, are very happy to have a taxable portfolio of assets and forego the tax relief. They prefer to have control over risk and control over access to the money too.”

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Comments

There are 6 comments at the moment, we would love to hear your opinion too.

  1. VCTs and EISs are not “pension alternatives”. If your client’s ATR precludes higher risk investments then if they have reached the lifetime allowance they can use the ISA wrapper or if not just non tax advantaged wrappers. No-one is forcing them into higher risk investments and the Exchequer has to balance tax breaks with other social responsibilities. The sooner this money grabbing bunch of self serving buffoons do the latter, the better.

  2. Every adviser needs to understand the VCT and EIS market rather better than those who have commented in this article. What is this notion that HMRC may remove the benefits because of the take up.
    There are clients out there who are very happy to take the extra risks, however they take a rather more pragmatic approach than the average IFA and there are some really good EIS and VCT managers out there. So research is very important, you can also offset losses and after 2 years they are IHT free. You need a little courage some research and clients who understand the risks. The pension market as we know it will die, alternatives have to be looked at, it really isn’t that difficult.

    • The problem with offsetting losses is that in order to offset losses you have to lose money, and most people don’t want to lose money.

      It’s not a one-way bet because you can’t know for certain you’ll have a big enough income tax bill in the years you can offset the loss.

  3. Trevor Harrington 12th April 2017 at 4:26 pm

    Paul Barnard is perfectly correct.

    What is it that makes these people think that they should get their tax back at 40%, juts because they happen to be lucky enough to earn very large salaries.

    Apart from anything else, it is robbing other areas of Government expenditure which enables these sorts of unjustifiable tax refunds ….
    For instance, my wife has just lost 6 years of state pension, and I have lost 2 years of state pension, because (quite rightly so) the Country cannot afford to pay those promises.

    Quite frankly the whole concept of higher rates income tax relief on pension contributions is completely unacceptable in the face of these sorts of cut backs, let alone allowing pension contributions to be uncapped again.

  4. Flat rate 25%, no LTA and after Pensions, ISAs, GIAs (Up to the free distribution allowances, soon to be £2,000 from £5,000 for divs) where do savvy Clients invest their money if not in EIS’s or VCT’s? EIS plans have a range of risks and some lower risk, lower return, plans are ‘asset backed/focused’.

    • A flat rate of tax relief would mean the Treasury giving (not merely allowing) an extra 5% on pension cont’s from all basic rate payers. What hope of that can there possibly be at a time when the Treasury is looking to reduce tax concessions not increase them?

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