Why VCTs are more attractive than ever post budget

Mercifully, and as predicted, VCTs were left untouched by Rachel Reeves' recent budget. This was in spite of very significant tax rises in other areas; including higher CGT rates, an IHT raid on family farms and businesses, and a new IHT hit on private pensions. From 2027, pensions will no longer be exempt from inheritance tax. This new measure will have frustrated the long-considered estate-planning of many families.

All of these harsher tax penalties: on pensions, CGT and IHT, have made VCTs even more attractive sources of tax-efficient investment. It must be said, VCTs were never free from IHT – they definitely form part of your estate when you die – however, the removal of IHT exemptions on other areas, particularly pensions, have put VCTs on a more even footing.

Like a pension contribution, VCT investors receive income tax-relief. This occurs when they buy new shares in a VCT offer, any subsequent dividends and capital gains are also tax free.* Unlike a pension, the tax-relief is a flat 30% and is not directly reinvested back into the product.

That said, an investor can usually reinvest their VCT dividends using a Dividend Reinvestment Scheme (DRIS), with the reinvested dividends qualifying for further income-tax relief. Whether or not an investor decides to use the DRIS option is a question of personal preference; reinvesting dividends into a VCT can create administrative headaches. This is because new share certificates are issued each time; over a number of years this can generate a lot of share certificates. It can be easier to pool dividends as cash and then use them for future lump-sum investments.

A VCT investor must hold their shares for 5 years, any liquidation of shares prior to 5 years can mean having to pay back your 30% income tax relief – this includes any shares bought using DRIS, each new group of shares must be held for 5 years. However – and here's the kicker – proceeds of shares sold after a 5-year holding period can be used to buy another VCT, unlocking a further 30% of your income tax bill. An investor cannot buy the same VCT within six months of selling shares in it, however there is plenty of choice on the market. This varies significantly from the tax-relief dynamics of a pension wrapper, where the tax-relief and investment is locked-in until drawdown. The current minimum drawdown age is 55 years old, rising to 57 in 2028.

Age restrictions also afflict the pension investor on the way in: income tax-relief on a pension contribution is only available for those below the age of 75. Happily, VCT investors suffer no such discrimination; anyone above the age of 18, as long as they're paying income tax in the UK, can qualify for income tax-relief when they buy new shares in a VCT.

Another distinction between a VCT and pension, is that only 25% of the pension is tax-free when first withdrawn – known as the Pension Commencement Lump Sum (PCLS). Further withdrawals, whether as lump-sums or income, are taxed at the marginal rate of income tax. In comparison, all VCT income is 100% tax-free up to an astonishingly high annual allowance of £200,000. There is also no CGT on realisations.

Interested in finding out more?

There are currently a number of high quality VCTs on offer, including Pembroke VCT and British Smaller Companies VCTs. Further quality offerings are available later this year, with Albion VCTs opening in January.

*Up to £200,000: Dividends from investments in VCTs of up to £200,000 per tax year are tax-free.