Extracting money from a pension

Kate needs a tax-efficient way to extract money from her pension

Kate has saved up a sizeable pension pot after having paid into her defined contribution pension for many years. She has been retired for five years and is financially comfortable in her retirement.

Her daughter has recently had her second child and, following pension freedoms reforms, Kate would like to take some money out of her pension to put towards the future education of her grandchildren. Despite the grandchildren not reaching school age for several years, she is keen to plan ahead and is investigating options to take money out of her pension in the most tax efficient manner.

Kate’s financial adviser suggests investing in a Venture Capital Trust

Kate talks to her financial adviser, who makes an assessment based on:

• her risk profile
• her investment time horizon: more than five years
• her attitude towards investing in smaller companies

Based on those factors, Kate’s adviser suggests investing in a VCT.

With a VCT, Kate can claim up to 30% income tax relief on up to £200,000 invested in any single tax year, provided she holds her VCT shares for at least five years. Kate can also benefit from tax-free dividends, and no capital gains tax to pay when she sells the shares. Kate cannot claim more relief than the income tax she has paid.

Tax benefits of investing money extracted from a pension in a VCT

The flow chart below illustrates how Kate can use VCT investments to reduce her pension income tax. There are two scenarios based on her tax rate: basic or higher. VCTs involve higher risk and differ from pensions and ISAs. They may not be suitable if you need guaranteed income or immediate access to funds. However, their tax benefits make VCTs an attractive option for some retirees. Individual circumstances vary, so suitability varies as well.

Note: Tax rates and allowances are correct for the tax year 6 April 2023 – 5 April 2024. For purposes of this illustrative example, we have assumed no gain or loss on investments, and it does not take into account any initial fees or ongoing charges that will be incurred. VCTs are high risk and inherently different from pensions and ISAs. When clients choose to sell VCT shares, they are often sold at a small discount to the value of their underlying net asset value, so the impact of this should also be considered when assessing any specific products. Please note, after selling shares in a VCT, it is not possible to claim tax relief on new shares bought in the same VCT within six months of the initial sale. Before investing in a VCT, investors should read the product prospectus and Key Information Documents (KID).