What every business owner needs to know about tax-efficient investing

If you’re a business owner or self-employed and you’re in a position to take a lump sum out of your business, pensions are a great place to begin. They’re one of the most tax-efficient ways of saving for your future, and you could potentially achieve tax relief of up to 60%.

But there are various limitations on the amount you can invest before you lose the tax relief element – and that’s when it’s worth considering other means of saving or investing.

To find out more, see our ‘Supercharge your pension tax relief like a Superhero‘ article

Aimed at investors with a higher risk appetite, Venture Capital Trusts (VCTs) offer another tax-efficient investment option for business owners and the self-employed.

Kerry explains: “These are essentially investment companies listed on the London Stock Exchange. They are set up to invest in UK small businesses. The government uses them to support local businesses, and they offer very generous tax breaks for investors.

“Whenever you invest in a VCT, you get a 30% tax relief on your income tax. That’s useful for higher or additional taxpayers. VCTs also pay tax-free dividends, and finally, there is no capital gains tax to pay when you sell them on at a later date.”

“You need to hold onto your VCT investment for five years,” say Kerry, “so you’ve got to make that five-year journey before you can benefit from those tax breaks.”

“But the window is far shorter than a pension, which may be important to you, especially if you’re young.”

You’re allowed to invest £40,000 per year in a pension before you have to pay tax (known as your ‘annual allowance’). Is there a limit to how much you can invest in a VCT?

“You can invest £200,000 each year in VCTs, so there’s plenty of scope, especially when they’re sitting alongside a pension fund. With careful financial planning, using a combination of pensions, VCTs, ISAs and bonds, you can create a healthy and tax-efficient income for your retirement.”

“The sooner, the better. You can only really plan for the tax regime in place at the time. So you need to keep checking in with your accountant, your tax advisor and your financial planner every year. Keep doing that, and you’ll have a solid plan for your retirement.”

Kerry explains: “The reason these investments are giving those tax breaks is that the government wants to encourage investment in UK small businesses. Some are listed on the alternative investment market, and some are private equity. So by their very nature, they are higher risk than, say, a pension or an ISA.

“We advise our clients to run a blended portfolio of VCTs to help mitigate the risk. Typically, they yield a 5% annual dividend, but the key point is that the dividend is tax-free.

“As an example, one of our clients has built up a portfolio of lots of different VCTs in excess of £1 million. This gives him a tax-free 5% annual return of over £50,000 in retirement. He obviously had to invest that money in the first place, and he used some of the profits from his business, but at the point of entry, he also benefited from a 30% tax credit as well.”

Kerry typically recommends clients invest no more than 10% of their assets in a VCT, because they are a higher risk than other investment or savings vehicles.

“We would look at the client’s entire asset base to ensure that what we advise is completely suitable and appropriate for them before recommending a higher risk investment, such as VCTs.”

As Kerry has explained, there are a range of tax-efficient investment options open to business owners and the self-employed. If you’re looking to build up a financial safety net or make the most of your money over the longer term, an Amber River financial planner can help you create a tailored savings and investment plan.

It’s important remember that diversification of your investments will help mitigate risks, but won’t remove them entirely. That’s because the value of investments, and any income you take from them, can fall as well as rise, and you may get back less than you invested. Please do not consider the contents of this article as financial advice.