Using a VCT to offset taxes on pension income

The Challenge

Recently retired clients often find it frustrating that the money they take out of their pension is still subject to income tax. For example, Marie has recently retired with a pension pot of £800,000. She wants to take out £50,000 from her pension, of which 25% (£12,500) will be tax-free, while the remaining £37,500 will be taxable. After Marie’s income tax-free allowance of £12,570 is taken into consideration, it means £24,930 is subject to income tax. As Marie is a basic rate taxpayer, this means her pension income of £50,000 leaves her with an income tax bill of £4,986. However, there is a way to ensure Marie, and other retirees like her, pay zero income tax on future pension income withdrawals.

The Solution

Marie discusses her situation with her financial adviser, who talks through the benefits and therisks of investing in a Venture Capital Trust (VCT). Marie’s adviser tells her that if she invested £16,620 into a VCT, she would be able to claim 30% income tax relief on her investment, which equals £4,986 (her income tax liability). This effectively makes Marie a non-taxpayer. Also, because most VCTs have an annual dividend target, Marie can expect to receive an annual tax-free income from her investment. VCT dividends are completely tax-free and there’s no HMRC requirement to declare them on tax returns.

The potential for regular tax-free VCT dividends could prove especially attractive for retirees, considering the tax-free dividend allowance was reduced to just £500 on 6 April 2024. As a reminder, basic rate taxpayers will be required to pay dividend tax at a rate of 8.75%, while higher rate taxpayers will pay 33.75%.

Investor’s capital is at risk.
For simplicity, this illustration does not take into account investment growth or charges for the investment. It is based on the current tax rules and personal allowances as at September 2024, which could be subject to change and depend on individual circumstances. Tax reliefs depend on a VCT maintaining its qualifying status and target returns may not be guaranteed.

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