Should you invest in a VCT? Investors can get tax-free dividends and a 30% income tax break – but beware the risks

The tightening of the screw on tax perks and investment limits for pension saving is tempting higher earners to add risky venture capital trusts and enterprise investment schemes to their retirement planning. 

Those who have already filled their pensions, through the lifetime or annual allowance, can still get a healthy tax relief boost from VCTs, but they are not for the uninitiated.

Here we give the lowdown on these high-octane tax saving options.

Most people know tax should never be the main motivation for choosing an investment but the generous breaks offered on both Venture Capital Trusts and Enterprise Investment Schemes – including 30 per cent income tax relief – are on paper hard to resist.

The taxman is not this generous for nothing.

The tax carrots are designed to attract money into Britain’s riskiest fledgling businesses, which the Government says are a vital component of the country’s future economic prosperity.

Both VCTs and EIS schemes put investors’ cash into high growth entrepreneurial businesses, companies that have fewer than 250 employees, and are either unquoted or listed on the Alternative Investment Market (AIM).

The main difference between them is that VCTs are more like investment trusts, spreading investors’ cash across a number of companies, and are listed on the stock market.

An EIS is a direct investment in one minnow company – although it is possible to spread the risk by investing in a fund that holds several schemes.

Ben Yearsley, co-founder of Wealth-Club, an adviser on tax efficient investing, says: ‘Essentially, those seeking tax-free dividends choose VCTs while growth investors tend to pick EIS. But while the tax breaks are enticing, you need to be happy with the underlying investments.’

Justin Modray, founder of website Candid Financial Advice, is wary. He says: ‘The tax breaks are attractive but the risks are high and making a bad or unlucky selection could land you with losses that wipe out the tax benefit – and more.

‘While I wouldn’t rule these investments out altogether, they are certainly not for the faint hearted. Also, bear in mind that if you want to get your money out in a hurry you might struggle to find a buyer unless the scheme offers a buy-back service’

Although the last tax year has just passed, there is a whole new basket of VCT and EIS tax perks available at the same level in the 2016-17 tax year.

Most VCTs launch new issues in the autumn, with the deadline the end of the tax year, although they will close if they reach their target earlier. EIS funds work in a similar way, but there are stand-alone opportunities during the year.