Economics and investment report: Venture Capital Trusts

A debate is bubbling in financial policy circles about whether some of our pension savings should be invested in young, fast-growing but risky companies that advocates believe could boost our retirement pots. The government so far says no, because the fees that venture capital funds demand are way above its 0.75 per cent pension charges cap.

That’s true. But thanks to the iron law of unintended consequences, it’s happening anyway.

Successive cuts in the amount high earners can contribute to their pensions have left many “maxed out”—if they put any more in, their fund will breach the current £1.055m lifetime allowance and trigger large tax bills. Instead, they are channelling cash into venture capital trusts (VCTs), tax-advantaged funds listed on the stock market that hold shares in risky smaller companies. Some buy shares quoted on London’s Alternative Investment Market, other “generalist” VCTs back small private companies, hoping to cash in when they are sold or floated on the stock market.

The VCT fundraising season is under way once again and if recent experience is any guide, it’s likely to be another big one. Flows into VCTs started to surge in 2016-7, when the pension lifetime allowance was cut to around £1m. Over the next three years the total invested went up 60 per cent, with private investors pouring in £731m in the year to April 2019.

And no wonder: they can claim 30 per cent income tax relief on up to £200,000 of contributions every year, receive tax-free income from dividends (yields of up to 5 per cent a year are possible, depending on the VCT) and avoid capital gains tax when they sell. With pension allowances much reduced and buy-to-let largely squashed, these are powerful incentives.

If you’re thinking about getting involved, there are a few things to know, enough in fact for more than one column.

For a start, you must self-certify as a high net worth or sophisticated investor if you plan to invest for yourself. Alternatively, talk to your financial adviser. For all their attractions, VCTs are complex vehicles with pretty high charges—an initial levy when you invest and ongoing fees of 2 per cent-plus per year. You must hold the shares for five years or you lose the tax advantages, and they are not always straightforward to sell. If you do, you should expect to receive at least 5 to 10 per cent less than the stated value of your investment (the net asset value).

In practice, however, most people don’t sell, choosing instead to hold their VCTs for the long term to generate tax-free income and capital growth. Next month, I plan to return to the subject and explore, among other things, where those juicy dividends come from and how best to take advantage of them.

Read Duncan Weldon on the spectre of "lowflation"