How IHT could bring the total tax you pay to 72%
Inheritance tax (IHT) receipts in June 2023 reached an all-time monthly high at £795 million, according to latest HMRC data. The tax is forecast to bring in £7.2 billion in the 2023/24 tax year – £8.4 billion by 2027/28.
Month by month more families are facing an IHT liability, as soaring inflation and property values tip estate values over frozen allowance thresholds.
How much could IHT erode a taxpayer’s pot? A recent article in the Telegraph estimates that, by applying death duties on your estate, the Treasury could take “as much as 72p from every pound you earn in your lifetime” on assets that are subject to IHT.
It calculated that 40% inheritance tax on the value of assets on which income tax and National Insurance have been previously paid equates to an effective marginal rate of up to 72% for business owners, under current tax rules. Non-business-owners earning £60,000 a year, would pay an effective tax rate of 56%.
Could that be avoided? How could you pass on more of your wealth? This article looks at some options available to experienced investors.
Inheritance tax in a nutshell
Your loved ones, other than spouse or civil partner, could typically face a 40% inheritance tax on assets you bequeath them over an allowed threshold.
If you are a single homeowner passing on assets to direct descendants, the tax-free threshold is up to £500,000 (£1 million if you’re married or in a civil partnership). This includes your £325,000 nil-rate band, plus £175,000 residence nil-rate band.
The residence nil-rate band is reduced £1 for every £2 for estates worth over £2 million; if your estate is worth £2.35 million you might lose it altogether.
There are various exemptions and reliefs available that can reduce the liability to the tax.
How might you pass on more of your wealth?
There are different ways experienced investors may be able to mitigate inheritance tax. Here we focus on Business Relief, commonly known as Business Property Relief – BPR, in short.
What is BPR and how does it work?
BPR was first introduced in 1976 to allow family businesses to be passed down through generations free of IHT. Its scope later widened, so now BPR is available for a range of assets – including certain private and AIM-quoted companies – in which you can invest.
If a company qualifies for BPR, its shareholders could benefit from IHT relief if they hold the shares for at least two years and on death, provided certain conditions are met.
Furthermore, there is no upper limit or allowance restricting how much you can invest. If conditions are met, the whole value of the investment – be it £10,000 or £10 million – could potentially attract 100% IHT relief.
Note: these investments are high risk (you could lose your capital) and must remain qualifying. Tax rules can change and benefits depend on circumstances.
How to invest in BPR-qualifying businesses
If you have the time and inclination, you could research and select BPR-qualifying companies and build a portfolio yourself.
Alternatively, it might be simpler to seek out ready-made portfolios or services run by reputable and experienced asset managers. Whilst more expensive, this saves time and helps ensure the companies selected are – and remain – BPR qualifying.
There are three main types of portfolios designed to deliver IHT relief:
1. AIM IHT ISAs
A typical portfolio will be diversified across 20-40 AIM-quoted companies, usually in different sectors. The fund manager will aim to deliver some growth whilst trying to mitigate volatility. AIM portfolios are likely to be more volatile than conventional Stocks & Shares ISAs. Read more on AIM IHT ISAs »
2. Inheritance tax (IHT) portfolios
An IHT portfolio is a managed portfolio of private companies that qualify for BPR. The managers tend to look for companies they believe are lower risk and with relatively predictable cash flows. Their goal is typically to preserve your capital so you can pass on as much as possible and spare your family a 40% IHT bill in the process. That said, IHT portfolios invest in small unlisted companies – these are by nature more volatile and illiquid than larger companies and thus much higher risk. Read more on IHT portfolios »
3. Forestry investment – if you are eligible
A forestry fund run by a professional manager allows investors to invest in commercial woodland. In addition to the potential for IHT relief after two years, as the trees grow, you could benefit from capital gains tax-free appreciation in the value of the timber (although not the value of the land) and no income tax liability on timber revenue. Because of the way forestry funds are structured, they are normally only open to very experienced or professional investors. Investors wishing to view specific fund information must first successfully complete a questionnaire designed to assess investment knowledge and experience – check to see if you qualify.
Other IHT-free options: EIS and SEIS
If you invest in EIS and SEIS it is worth remembering these should qualify for IHT relief under the BPR rules after two years of investment – part of the generous tax package they offer to temper the higher risks of investing in small young businesses.
EIS and SEIS should not be used exclusively as an IHT planning tool. Like IHT portfolios, EIS and SEIS are high risk and you could lose your capital.
What to do next?
Having been prudent enough to accrue wealth during your lifetime, you may not wish to have the taxman take up to 40p of every £1 you’ve worked hard to save over the years. Read our free factsheet to explore some of the options.
If you have any questions on the guide or another investment matter, please get in touch.
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Inheritance Tax portfolios
See our IHT portfolios section for more information on how to beat the IHT trapRead more about Inheritance Tax portfolios