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Investors want to achieve the best returns possible from their investments. This includes factoring inflation, fees and taxes into their calculations. Pensions have long been held up as one of the most powerful “vehicles” for tax-efficient investing. Yet how do they compare to the Enterprise Investment Scheme (EIS) and other venture capital (VC) schemes?
Below, our Bure Valley Group team examines pensions in 2024-25 and how they compared to VC schemes for investors. We hope these insights are useful. To learn more about our EIS projects and other early-stage opportunities, visit our portfolio page. For enquiries regarding our latest projects and funding, you can reach us via:
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Why are pensions popular?
In the UK, pension rules have been crafted to try and encourage long-term saving towards retirement. In particular, an individual making pension contributions can access “tax relief” equivalent to their highest marginal rate of income tax.
For instance, suppose a Basic Rate taxpayer makes a contribution of £80 from his pay. Since his highest marginal rate is 20%, his contribution is effectively “boosted” to £100. The tax relief rules are even more powerful for those on the Higher and Additional Rates, boosting the aforementioned contribution by 40% and 45%, respectively.
In 2024-25, the maximum “annual allowance” to make pension contributions each tax year (whilst receiving tax relief) is £60,000. This is £20,000 higher than two years ago. However, if an investor earns less than £60,000 in a tax year, their earnings will be the “cap” on their annual allowance instead.
The benefits do not stop there for pensions. Unspent funds in a pension “pot” can be passed down to beneficiaries free of inheritance tax (IHT) upon the owner’s death. Also, all growth from interest, capital gains and dividends within a pension is tax-free.
Why VC schemes can be useful
Pensions do come with their limitations. Notably, benefits cannot be withdrawn from a scheme before an individual reaches their Normal Minimum Pension Age (NMPA). In 2024-25, this stands at age 55. By 2028, the NMP is expected to rise to 57.
As such, successful investors who wish to retire earlier than this—drawing “passive” income from investment sources—may find themselves restricted by such rules. Pensions are also limited in how much investors can contribute to their schemes. Whilst a £60,000 annual allowance may sound generous, it can be quite restrictive on higher-net-worth individuals.
UK pension providers also tend to restrict their members’ access to only “safer” investments, such as government bonds (gilts) and publicly listed companies on established stock exchanges, such as the LSE. This can make it difficult for investors to access “higher growth opportunities”, like startups, would could offer greater potential for wealth building.
Recently, there has been some effort by the UK government to try and open up the pensions industry to more unlisted equity opportunities. In 2023, Chancellor Hunt announced that he had encouraged nine of the UK’s largest pension providers to commit 5% of their default funds to buy shares in private companies by 2030. Yet the story here is still developing.
There is good news, however. VC schemes can help investors overcome many of these restrictions to pensions.
Using VC schemes to compliment pensions
Since there are three primary VC schemes in the UK, it will help to focus the comparison on one important type—the Enterprise Investment Scheme (EIS). We do not argue that VC schemes should replace pensions in a client’s retirement plan. However, they can play a key supplementary role in addressing some of the shortcomings of pensions for investors.
Firstly, EIS offers a wider scope for annual contributions. In 2024-25, the annual allowance for pensions is £60,000. However, an investor can invest up to £1m per year into EIS-qualifying investments (or up to £2m if they are classed as “knowledge-intensive”).
EIS investments also retain some of the key benefits of pensions. In particular, EIS shares held for at least two years are exempt from IHT (similar to funds held in a pension “pot”). They also enjoy a host of tax advantages, such as up-front 30% income tax relief.
For investors, EIS also holds good news by enabling wider access to the UK’s early-stage investment landscape. Many of these companies have significant “runway” ahead of them for commercial growth, offering promising returns to investors (albeit at a higher risk compared to listed companies typically favoured by pension providers).
In summary, pensions and VC schemes do not need to compete in an investor’s retirement strategy. Indeed, they can complement one another, aiding individuals as they pursue their long-term goals. To achieve the best synergy, it can help to consult an experienced financial adviser who can assist you with constructing a personalised portfolio which accounts for your unique objectives, time horizon, risk appetite and financial circumstances.
Invitation
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