VCT tax relief calculation - drawing down from SIPP to buy VCTs to avoid LTA charge at age 75

PaulPension

Hi,

I’ve been reading this forum for a number of months now and have learn a lot from all the excellent discussion, but one thing that I’m still not clear about is exactly how the 30% income tax relief works, particularly where some income is is taxed at 20% and some at 40%.

As background, I am retired and drawing down on my fully crystallised SIPP, which due to a few good investing years has grown well above the crystallised value. I’m now concerned about the LTA test at age 75, so I’m now considering taking out some large lump sums from my SIPP and investing into VCTs.

I’d like to do this in a way that minimises my income tax liability, so if I understand the 30% VCT income tax relief correctly, then I “think” that if I drawdown £87,970 from my SIPP and then invest £75,400 (the amount that is subject to income tax) into VCTs, then I will effectively pay no income tax at all, once the 30% tax relief is received. I would greatly appreciate it if someone can check that my understanding is correct with regards to ending up paying no income tax ?

Here are my calculations on how I worked out both how much I drawdown from my pension (£87,970) and how much of that to put into VCTs (£75,400):

I have the normal income tax allowance of £12,570 and no other income

So if I drawdown £87,970 from my SIPP in one year, then the income tax I pay will be as follows:

   On the £37,700 over the tax free allowance the tax will be 20%, so £7,540 basic rate income tax

   On the next £37,700 the tax will be 40%, so £15,080 higher rate income tax

So the total income tax payable = £7,540 + £15,080 =  £22,620 total

Then from the £75,400 invested into VCTs, this (if I understand correctly) will provide a tax relief payment of £22,620 (£75,400 x 30%), which equals all of my income tax paid, thereby resulting in effectively paying zero income tax.

Hopefully this makes some sense and those of you who clearly understand the way the 30% tax relief on VCTs can let me know if got this right … or where I misunderstood.

NoMore

ok I fully admit I know nothing about VCT and their tax relief, but where does the 75k come from to invest if you take 87970 out of your sipp, that leaves 65350 after tax, if your topping this up with other income has that not been taxed as well ? So your calculations are out of wack? Or Does VCT work like a pension contribution and they top your account up for you with tax relief ? I'm not sure if it does.

Disclaimer this may be totally wrong and stupid, fully expected jamesD or some other more knowledgeable poster to tear me apart!

Dazed_and_C0nfused

AIUI VCT is a tax reducer, a bit like Marriage Allowance and Married Couple's Allowance.

Your income tax liability is calculated as normal and them VCT relief is a deduction from that.  I don't think VCT relief can result in a reduction to less than £0 i.e. if the Self Assessment tax liability is £10,000 and VCT relief is £12,000 then the liability is reduced to £0 but you don't get a refund of the extra £2,000.

Do you currently complete Self Assessment returns?

jamesd

Your calculations look OK as to tax cost and VCT buy total needed.

Do you really need to go that far into higher rate or is there a good chance that many years at the top of the basic rate band will suffice? A few years maybe nil or 10k into higher rate can cut down on the bit at 40% and still will sometimes be enough. In other cases it really does need a big chunk initially.

NoMore, some of the money comes from elsewhere, HMRC refunds 30% of the purchase price of the VCT buy, capped at the tax otherwise payable in the year of purchase. Doesn't buy more VCT(s) for you because they don't know which ones you'd want. They pay it via PAYE tax code (pensions use PAYE with no NI) or lump sum into bank account or sometimes by cheque if they don't have bank details.

PaulPension

Thank you so much for checking my calculations and hence confirming my understanding of how the tax relief works.

As far as thinking that it makes sense to pull out large lump sums from my drawdown pot, it really comes down to my misunderstanding of how the LTA check works at age 75. I’d (incorrectly) thought for many years that it was compared to what the LTA is when I’m 75 … I now understand that the check uses the LTA at the point of crystallisation, about 5 years ago. Over the last few years my gains with my drawdown pot have been very good, since I invested in some good global growth stocks, so the drawdown pot is a lot over the LTA at the moment and I intend to continue investing in similar global growth stocks for at least a few more years, so I’ll need to pull out similar amounts in future years to slowly get below the LTA … a very nice problem to have I know

Again I wanted to thank you for your help. The people who contribute to this forum really are excellent and I hope in the future to be able help folks on the forum in the way you have helped me … perhaps once I’ve gone through the experience of actually buying some VCTs and seeing how they perform.

My next task is to identify which of the many VCTs that are available are the best ones for me to invest in. I see lots of folk mentioning Barronsmead on these forums, so I’ll have a good look at what they offer.

Alexland

PaulPension said:

I see lots of folk mentioning Barronsmead on these forums, so I’ll have a good look at what they offer.

I'm not sure it was 'lots of folk" just me and james chatting. Although I am a fairly experienced investor this is my first year doing VCTs and it's just a small toe in the water probably £23k total which would nearly fully offset my income tax as I keep my income under £50k by reducing my hours and making heavy pension contributions. My choice is slightly limited by what's still available this tax year but they seem a solid choice. WC did a data visualisation which should give you a feel for the VCTs with healthy inflows.
https://m.youtube.com/watch?v=bg3VBriM1Nw

Albermarle

and I intend to continue investing in similar global growth stocks for at least a few more years, so I’ll need to pull out similar amounts in future years to slowly get below the LTA 

I don't want to be the Christmas Grinch, but there is a possibility that the markets might turn in a negative direction, and you should therefore keep your plans flexible .

PaulPension

Alexland, thank you sharing that VCT inflows visualisation … that is really neat. I’ll probably look into more detail on the other ones that had bigger inflows, although I realise that following the herd isn’t always the best thing to do, but it feels like a good starting place for me as a newbie to VCTs.

Albermarle, that’s a very good point about keeping flexible. I’m perhaps a bit more towards the “trader” side of investing, since (probably contrary to most advice I’ve read), I tend to move in and out of investments depending on a combination of technical analysis and news, so hope to miss the majority of big falls, but also don’t get all of the big peaks. So far this approach has worked well for me, but if course I could get caught out badly one day !!

jamesd

PaulPension said:

...
As far as thinking that it makes sense to pull out large lump sums from my drawdown pot, it really comes down to my misunderstanding of how the LTA check works at age 75. I’d (incorrectly) thought for many years that it was compared to what the LTA is when I’m 75 … I now understand that the check uses the LTA at the point of crystallisation, about 5 years ago. Over the last few years my gains with my drawdown pot have been very good, since I invested in some good global growth stocks, so the drawdown pot is a lot over the LTA at the moment and I intend to continue investing in similar global growth stocks for at least a few more years, so I’ll need to pull out similar amounts in future years to slowly get below the LTA … a very nice problem to have I know

To expand a bit on that:

1. When you crystallise a percentage of the lifetime allowance as it is at that time is used and this percentage is added to any previous percentages and carried forward. If you'd previously crystallised 100k with a million allowance and then crystallised another 200k also with a million allowance you'd have used 30% total. You'd have had 75k tax free lump sum and ignoring investment performance would have 225k in the flexi-access drawdown account.

2. You can draw whatever you need from the flexi-access drawdown account until your 75th birthday is reached. On that day say the flexi-access drawdown account has a balance of 500k. That's 275k more than the initial amounts added to the flexi-access drawdown account. If the LTA is now 2 million that would require 275 / 2000 *100 = 13.75% more LTA use and if you have that available there's no charge to pay. If the allowance was still a million and the pot balance on that day had grown to a million, the growth would be 775k and that would require 77.5% of the million LTA as it is on this date to be within the allowance. But previously 30% (of the earlier LTA) had been used so only 70% of the million as of age 75 LTA is still available, so a charge would be due on 7.5% of the increase.

3. If you'd withdrawn the 275k or 775k growth before your 75th birthday no lifetime allowance would be used, which is why we'd normally tell people to do that. Subject to inheritance planning considerations.

While it's normally explained and tracked in percentages, there are some very slight technical calculation differences that rarely matter.

PaulPension

Your examples of how the age 75 calculation works is very helpful jamesd and shows me that I hadn’t understood it correctly before your explanation. 

My situation is that I’ve used almost exactly 100% of my LTA of around £1 million when I crystallised and took £250,000 tax free, so if I understand correctly then I need to ensure that my drawdown fund has no more than £750,000 when I’m 75, otherwise I’ll be taxed on the amount above £750,000.

So first of all I need to get the pension fund down to £750,000, hence my use of large lump sum drawdown to put in VCTs. Once I’ve got it down to £750,000, then my plan is to take all growth above £750,000 as drawdown income each year, with anything above the higher rate income tax threshold going into VCTs and getting the 30% tax relief.

PaulPension

One further question on VCT tax relief and how it interacts with income tax bands …

Does anyone know if by getting the VCT tax relief, does it or can it change your tax band ? So for example if I was in higher rate tax before investing in VCT, then after investing in VCT had reduced my income tax bill to zero, would I still be in the higher rate tax band or would I have moved to basic rate ?

The reason for asking is in relation to CGT for unwrapped investments in a GIA .. would they be taxed at basic rate (10%) or higher rate (20%).

I am assuming that investing VCTs and getting the 30% relief has NO impact on tax band, but wanted to check my understanding. It would seen to be too good to be true if buying VCTs also reduced tax band as well !!