In light of the new, much-reduced limits on pension contributions it’s worth considering the alternative options for saving out of your income. Here are some to choose from — with different levels of risk to suit all.
Completely tax-free investments include Premium Bonds, National Savings Certificates (£15,000 per issue) and Children’s Bonus Bonds (£3,000 per issue).
Individual Savings Accounts
With the Government committed to supporting ISAs, at least in the short term, there is considerable opportunity for individuals to accrue substantial ISA portfolios over time.
The current annual ISA limit of £10,200 (£5,100 for cash ISAs) is due to rise to £10,680 (£5,340 for cash ISAs) for the 2011/12 tax year.
While not completely tax-free, as tax credits on dividends cannot be reclaimed, they are free from capital gains tax on disposal and can be used as a source of capital or income if required.
A major benefit is that ISA investments do not have to be declared in a tax return. Given that many people who have been contributing over the years to ISAs (and their predecessor, PEPs) now have ISA portfolios worth £400k plus between husband and wife, their attraction is clear.
Qualifying Investment Plans
Previously known as Maximum Investment Plans (MIPs), these contracts are regular premium insurance policies, providing individuals with both an investment and life assurance element.
Normally established for a ten-year period, provided premiums are maintained for 75% of the term and do not vary within specified limits, tax within the fund is limited to insurance company rates of between 15% and 20%. On encashment there is no further higher rate tax liability and they can be stripped down piecemeal after ten years as a source of retirement income on which the investor has no personal tax liability.
The investor can select the underlying investment funds, which are collectives managed by the leading fund management groups.
While attractive for retirement planning, QIPs can also be used to help fund future school or university fees.
Venture Capital Trusts
VCTs are intended to provide capital to small and expanding companies, as an alternative to bank lending, with the aim of growing the business and generating a profit for the VCT.
Individuals can invest up to £200,000 per tax year and benefit from 30% income tax relief, which is claimed via their self-assessment tax return. In addition, dividends are tax-free and there is no capital gains tax should the VCT be sold. There is, however, a minimum holding period of five years to continue to benefit from the 30% tax relief.
For the current tax year, many VCTs are taking advantage of the feed-in tariffs introduced in the solar energy field via structured VCT investments.
Enterprise Investment Scheme
Similar to VCTs, the EIS can be used to invest in smaller businesses, but while the VCT is likely to have several investments, an EIS arrangement will only invest in one company, which increases the element of risk for the investor.
The EIS provides 20% income tax relief for investments up to £500,000. There is a minimum holding period of three years and the EIS can also provide CGT deferral.
Any capital gain realised on sale is not taxable provided income tax relief has been received and not withdrawn. Losses may also be allowable for income tax purposes. After two years the EIS investment is exempt from inheritance tax.
It is now possible to carry back all of the income tax relief to the previous tax year, e.g. relief for investments made in 2010/11 can be set back to 2009/10.
Selecting a suitable investment
Some of the investments mentioned above carry a higher level of risk to capital than others and therefore it is important that you give appropriate consideration as to whether any particular investment is commensurate with your personal appetite for investment risk. We can assist you with this assessment, if required.
By Mike Fosberry, Head of Financial Services at Smith & Williamson