No lifetime allowance left? Why not look at Venture Capital Trusts?
The recent changes to the pension lifetime allowance and dividend taxation has brought to light the usefulness of Venture Capital Trusts (VCTs) for retirement planning for doctors. This is highlighted by the rise in demand for VCTs; the Association of Investment Companies recorded that VCTs have raised £458 million for the 2015/16 tax year, more than any other year in a decade. With investments of up to £200,000 per doctor per tax year, there is no capital gains tax associated with VCTs and doctors will also receive a tax rebate to the value of 30% of the amount invested (on condition that the VCTs are held for at least 5 years). For example, if a doctor were to invest £100,000, he or she would receive £30,000 in the form of a tax rebate, making VCTs an incredibly tax efficient method for retirement planning as an alternative or perhaps alongside using a pension.
Pension lifetime allowance has significantly decreased
As many doctors will now be aware, the pension lifetime allowance has reduced from £1.25 million in the previous tax year to £1 million in the current tax year, which is significantly lower than the 2010/2011 tax year when the lifetime allowance was £1.8 million. This is a problem particularly for younger doctors with decades of pension growth ahead of them. Additionally, a tapered annual contribution limit has been introduced which erodes a doctor's annual allowance by £1 for every £2 of adjusted annual income earned over £150,000 down to a minimum of £10,000. Therefore a doctor who earns £210,000 a year would have an annual pension allowance of £10,000. The penalty for exceeding the lifetime allowance is a severe tax charge of 55%.Therefore it is wise for doctors to at least consider VCTs as a tax efficient alternative method of saving for retirement if you are likely to exceed your annual or lifetime allowance.
Change in dividend taxation
The new legislation regarding dividend taxation has allowed doctors to receive £5,000 of dividends a year without being taxed. For example, a doctor would need a FTSE 100 portfolio of well over £100,000 (at the current yield) before they are required to pay any tax on dividends received. However for dividends that exceed £5,000, the taxation rates are as follows:
• 7.5% basic rate
• 32.5% higher rate
• 38.1% additional rate
Therefore for doctors making private earnings through Ltd Companies and for high earning doctors in general are likely to be worse off than before the new tax rules were implemented due to the increase in the additional rate of dividend tax from 37.5% to 38.1%. It is therefore wise and more tax efficient for doctors with Ltd Companies to start using VCTs to extract their profits.
VCT rule changes
The Finance Act 2016 has introduced new legislation to ensure that investment into VCTs are directed towards higher potential, smaller companies that are likely to yield the highest long term returns. However unlike the change in pension legislation, the new rules introduced for VCTs do not affect the VCT tax wrapper itself, which means VCTs will still benefit from the same tax advantages as they previously have done. The new rules are listed below:
• A lifetime cap of 12 million on the amount of funding that a company can receive from VCTs and Enterprise Investment Scheme (EIS) Sources.
• An age limit of seven years during which the first VCT or EIS investment must be made.
• A restriction on VCT money being used simply to transfer ownership of a company or trade – VCT money must explicitly be used to fund growth and development.
• Tighter restrictions on what VCTs can do with their money while waiting to make qualifying investments.
The new rules will not affect existing VCT investments and there is no requirement to sell any holdings that exceed the new limits. The new rules only apply to new VCTs issued.
An interesting extension to the new legislation that has been introduced is the concept of 'knowledge – intensive' companies. Companies that are deemed to be highly skilled or meet specific 'innovation' criteria will benefit from an increased funding cap to £20 million from the standard £12 million. This is designed to encourage investment into new companies with greater growth potential.
However it is important to remember that thorough research into which VCTs you are most likely to benefit from is required before investing. The reduced number of VCTs open for investment in recent years, along with the increased demand means that the most popular VCTs will become 'out of stock' very quickly, so once you spot the right opportunity, act!
If you are a doctor looking for alternative tax efficient investments please contact Richard Higgs on 0117 966 5699 or email@example.com