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.”
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 The shares must be held for a certain amount of time, usually three years, or income tax relief will be withdrawn.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.”
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.”