Balancing act: Record numbers of families are being stung with inheritance tax bills
Record numbers of families are being stung with inheritance tax bills, figures from Revenue & Customs revealed last week. More than £7.1 billion was paid in such death duties last year – up by £1 billion on the year before.
The number of families forced to pay death duties has increased by 24 per cent over the last year to 41,000. ‘It’s not a rich person’s tax any more,’ says Helen Morrissey, head of retirement analysis at wealth platform Hargreaves Lansdown. ‘The inheritance tax allowance has been frozen since 2009, which means growing numbers of families are being dragged into its orbit.’
The simplest ways to cut your potential inheritance tax bill involve giving away sums to loved ones during your lifetime – or spending it.
However, there are also ways to invest that allow you to hold on to your money, shield it from inheritance tax – and that could even grow your wealth.
Your estate will be liable for inheritance tax if it is worth over £325,000 – or £650,000 for a couple. You also have an additional allowance of £175,000 if you are passing down a family home to your descendants.
Investing in small companies can help
If you buy shares listed on the Alternative Investment Market (AIM), they are free from inheritance tax once you have held them for two years.
Invest successfully and the savings could be huge, as any assets above the inheritance allowances are walloped with a 40 per cent tax bill. However, the inheritance tax benefit is a reward for taking considerable risk by investing in small, often untested UK-listed companies.
Therefore this approach is only right for experienced investors who understand the risks and can afford to lose money should it not work out.
AIM is the London Stock Exchange’s market for small and medium-sized companies in their growth stage. Inevitably these companies are much riskier to invest in than those that have been established for a long time.
They are more likely to go bust, or see their values plummet. For example, the share price of AIM-listed outsourcing group iEnergizer collapsed last week, when it announced it was delisting from the exchange. That will have left some investors nursing losses and unable to trade their shares as easily.
But equally, because they are still in their infancy, AIM companies are more likely to see rapid growth.
Successful examples include household names such as clothing group Asos, airline Jet2 and luxury tonic water business FeverTree. Had you invested during their early stages, you would have made impressive returns. If you had invested £1,000 in FeverTree in 2014 it would now be worth £7,438.
‘AIM shares can be a lot more risky and more volatile than other shares and assets,’ warns Alice Guy, head of pensions and savings at investment platform Interactive Investor. ‘You could end up saving tax but losing out on investment growth, especially if you’re not diversified.’
Alex Davies, chief executive and founder of tax-efficient investment service Wealth Club, warns that AIM investments may be difficult to sell, and that it is hard to construct a well-diversified portfolio of AIM stocks to spread your risk because there is a limited number of them available.
‘Corporate governance rules for AIM are more relaxed compared to the London Main Market, and the fact that there are fewer large institutional investors mean scrutiny isn’t what you might find elsewhere,’ he adds. ‘That’s led to a number of scandals over the years, where companies have either collapsed or been the victims of frauds.’
Davies believes that making a success of AIM investing is less about picking superstar companies and more about avoiding terrible investments so that your potential inheritance tax savings are not wiped out by poor share price performance.
How do the tax breaks work?
Investing in AIM shares is one of the fastest ways to reduce your inheritance tax position, says Mike Stimpson, partner at wealth manager Saltus. ‘It can provide 100 per cent inheritance tax relief, saving you up to 40 per cent in tax.’
You can also hold AIM stocks in your Individual Savings Account, where they are also sheltered from income tax, capital gains tax and stamp duty.
Not all AIM shares are eligible. If an AIM company has a listing on a recognised overseas exchange or invests mainly in property or shares, then it will not qualify.
The tax relief will also be lost if the company delists from AIM and moves to the main market or if the company is acquired. Funds that invest in AIM stocks also do not qualify for the relief, as the shares have to be held directly.
Shares only qualify if they are eligible for Business Property Relief. This was a tax break introduced in 1976 to allow family businesses to be passed down through the generations free of inheritance tax.
Over the years, its scope has broadened and most AIM shares now qualify, but you will need to check before investing.
Ask the experts to help with planning
Many will find it safer and easier to use an expert to manage their AIM IHT portfolio. Investors can buy a complete portfolio, with a number of qualifying shares, handpicked by a fund manager.
Many of these portfolios have performed poorly over the past year, although they have achieved better returns than the AIM market as a whole.
This demonstrates the importance of understanding the risks, but also with prices considerably down it may be easier to find a bargain than in the past. Jason Hollands, managing director at investment group Bestinvest, says it is always best to use an expert to get the tax break.
‘The status of a company can change. This is why it is wise for anyone considering AIM portfolios to appoint a professional manager rather than do it themselves,’ he says.
‘I would urge people considering an AIM portfolio to think more broadly about ways to mitigate IHT and to consider taking financial planning advice.’
Other tactics that can help reduce tax bills
There are a number of other ways to reduce your family’s inheritance tax bill. Other early-stage investments such as Enterprise Investment Schemes and Seed Enterprise Investment Schemes offer inheritance tax breaks, but come with significant risk.
Our sister publication This is Money has more information at thisismoney.co.uk/eis.
Pensions can also be a good way to pass on wealth. Assets held in a pension are automatically free from inheritance tax if you die before the age of 75. After that, anyone who inherits your pension will be taxed at their income tax rate.
Jonathon Marchant, fund manager at wealth manager Mattioli Woods, adds: ‘AIM stocks can have a role to play in reducing liabilities. But, while we know that AIM has produced and continues to offer access to some fantastic businesses, it should be seen as a part of a broader, diversified investment portfolio.’
I built an AIM portfolio for Mum, 85
Helping hand: Sanjay Arora
Sanjay Arora, an accountant and property developer from Berkshire, helped his mother, Kamla, 85, to put her cash Isas into a portfolio of AIM stocks specifically for inheritance tax purposes in 2017.
‘Her health had deteriorated and obviously we didn’t know what her future was,’ he explains. ‘We looked for ways to mitigate that 40 per cent tax liability.’ Sanjay, left, felt that AIM portfolios offered through the Wealth Club would be a good place for his mum’s Isa savings, totalling more than £70,000. ‘Obviously the AIM market is a risky investment, but I was quite impressed by a couple of managers,’ Sanjay says.
‘I did my research and they seem to invest in young companies which have some track records. They tend to go on to the board of some companies too, giving them even more knowledge.’
Six years on and Sanjay says portfolios have ‘done OK’ but reiterates that the real benefit is the IHT mitigation. This will have shielded a potential £28,000 from the taxman.
‘With the tax at 40 per cent, this is really about estate planning,’ he says.
