Helping additional-rate taxpayers use VCTs to earn a tax-free income stream

Our Venture Capital Trust (VCT) planning scenarios are based on situations advisers often encounter, making them a great starting point for discussions with your own clients.

The annual dividend allowance has shrunk from £5,000 in 2017–18 to just £500 today, and dividends over that amount can be taxed at up to 39.35% for additional rate taxpayers. However, dividends paid by venture capital trusts (VCTs) are exempt from income tax. For clients looking for alternative income sources, this makes VCTs a valuable and tax-efficient option.

Meet Dinesh

In this client planning example, Dinesh (60) is a company director with a £1 million pension. He would like to reduce his working hours until retirement at 65. He planned on taking a tax-free lump sum of £200,000 from his pension, to potentially invest in dividend-paying investments. However, as an additional rate taxpayer, Dinesh’s financial adviser warns him that after using up his £500 dividend allowance, he can expect to pay dividend tax at 39.35% on any dividends above that amount.

Using a VCT for regular tax-free income

After talking through the investment risks, Dinesh’s financial adviser recommends investing £200,0001 into a VCT with a 5% annual dividend target. Assuming the dividend target is met, Dinesh could receive annual tax-free dividends of up to £10,000 to supplement his income. He can also claim upfront income relief of up to 20% on his investment (£40,000), although the amount of income tax relief claimed cannot exceed the amount owed.

For comparison purposes, a typical £200,000 stocks and shares investment would have to generate £16,158 in taxable annual dividends, a dividend yield of 8.25%, to receive the same £10,000 of net income2 compared with the 5% tax-free yield from the VCT.

¹ £200,000 is the maximum amount that can be invested in VCTs in a single tax year. The amount of upfront income tax relief claimed cannot be more than the tax liability. ² This assumes the £500 annual dividend allowance has been used elsewhere.

Investor’s capital is at risk. This illustration does not take into account investment growth or charges for the investment. It is based on tax rules and personal allowances at April 2026, 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.