How advisers can help income-seeking clients overcome shrinking tax allowances

We’re all having to do more with a bit less these days, and one of the things more noticeable since the cost-of-living crisis began has been the concept of ‘shrinkflation’. That’s the name given to the dark art of companies reducing the size or quantity of a product while keeping it at the same price. It can mean smaller chocolate bars, fewer crisps in the bag, or fewer tea bags in a box. Basically, the purchase price remains the same, but the cost per unit rises and you are getting notably less for your money.

 

This lifestyle change, of getting less now than you did before, is also being felt in the pockets of UK taxpayers. ‘Fiscal drag’ has meant more people have been pulled into higher tax brackets and are paying more tax even with the same tax rates. At the same time, tax allowances have been shrinking over the past few years, and many are significantly lower in 2024 compared to earlier times. Let's look at some specific examples:

• Capital Gains Tax (CGT) Allowance: This annual allowance applies when you sell an asset, such as property or investments, for a profit. For the 2024/25 tax year, the CGT allowance has been cut to just £3,000. This is quite an alarming decrease from the £12,300 allowance that could be claimed as recently as 2022/23.
• Dividend Allowance: This applies to dividends received from stocks owned. In 2017/18, the annual dividend allowance stood at £5,000, whereas for the 2024/25 tax year, it has shrunk to a less than generous £500.

The overall effect of shrinking allowances is that many of your clients are likely to be paying more in tax, but with much less income at their disposal. Clearly this could have a significant impact on many clients, and is something advisers would like to be able to help with.

Has finding sources of tax-efficient income gotten harder?
From our conversations with financial planners, we know at Triple Point that helping clients achieve a desired income level sometimes requires an innovative approach. It often involves devising a tax-efficient strategy that lets clients withdraw specified amounts from different investments each year to make the most effective use of their tax allowances. For many advisers, though, shrinking CGT and dividend tax allowances has made such strategies harder to implement. Given that tax allowances have been slashed so dramatically, how can advisers help clients stay tax-efficient while drawing income from different pots of money?

Changes to those tax allowances mean advisers may need to consider alternatives where clients can derive income in the most tax-advantageous way. Fortunately, there are still some areas of the UK investment universe that offer compelling tax benefits for investors. With Venture Capital Trusts (VCTs) for example, investors are still entitled to claim 30% income tax relief on the sum they invest, up to an annual investment amount of £200,000, and provided the client holds onto their investment for a minimum of three years.

For many clients seeking an income, the biggest advantage of owning VCT shares is not the upfront income tax relief they can claim, but is, in fact, the tax-free income they can earn from VCT dividends.

And while cuts to tax allowances have impacted other areas of investment, the tax reliefs available through VCTs (and the Enterprise Investment Scheme) have not been similarly targeted.  This is because these reliefs are incentives, designed to encourage more investment into higher-risk companies that the UK economy relies on for much-needed growth. Just last year, the UK Government announced an extension to the VCT and EIS sunset clause beyond 2025. Of course, there are no guarantees, but the success of the VCT scheme over the last 30 years has been apparent and shows no signs of fading. According to the Association of Investment Companies, the 2023/24 tax year was the third highest on record for VCT inflows, with £882 million raised to invest in fast-growing businesses.[1] That’s an even more impressive amount of money invested considering the challenging economic climate. VCTs clearly aren’t going anywhere, and every year, more Britons are recognising the value of VCT tax reliefs and especially the income they can get from tax-free VCT dividends.

Advising on life events with Triple Point

At Triple Point, we say that “significant events need significant planning” because it helps to highlight the advice opportunities for advisers. The client planning scenarios we use have been built from years of conversations with financial planners about how, when and why they recommend tax-efficient investments to their clients. We think these scenarios could be used to help more clients feel financially confident about facing up to some of life’s big challenges, including finding more tax-efficient sources of income, and even some of the smaller ones too.

 

To find out more about how VCTs can help with life events and other client goals, visit https://vct.triplepoint.co.uk.

 

 

 

 

Important information

Tax treatment depends on the individual circumstances of the investor and is subject to change. This financial promotion has been issued by Triple Point Administration LLP which is authorised and regulated by the Financial Conduct Authority no. 618187.

 

[1] https://www.theaic.co.uk/aic/news/press-releases/vct-fundraising-is-third-highest-on-record