Three ways to beat Inheritance Tax
Archived article: please remember tax and investment rules and circumstances can change over time. This article reflects our views at the time of publication.
Receipts from inheritance tax (IHT) bolstered the Treasury’s coffers to the tune of £4.65bn last year: a 21% increase on the previous year and 71% on 2010-11, George Osborne’s first year at No 11.
To make matters worse, there is little sign of future respite. Forecasts from the Office for Budget Responsibility suggest £21bn will be paid by estates between 2017-2021.
Osborne’s main residence nil-rate band – which will be introduced in stages from 2017-18 – does little to alleviate the problem. It will reach £175,000 by 2020-21 but will apply only to a property that has been your main residence, provided you pass it on to your direct descendants.
What’s more, the allowance is clawed back £1 for every £2 over £2 million. If your estate is worth £2.35m you lose the allowance all together (2020-21).
The main residence nil-rate band does nothing to help those with a large proportion of their estate in cash or investments. Nearly 20,000 estates paid IHT on cash and nearly 17,000 on securities in 2013-14.
So, what can you do? How could you pass on your hard-earned wealth without suffering from such a punitive tax? The most hated tax of all.
One way is investing in companies qualifying for business property relief (BPR). Unlike with gifts or trusts the money becomes IHT free after two years and you retain ownership of the investment.
Here are three ways to invest and benefit from BPR.
1. Invest in inheritance tax portfolios
An IHT portfolio is a managed portfolio of companies that qualify for BPR. The managers tend to look for companies they believe are low 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 companies. These are generally more volatile and illiquid than larger companies and much higher risk. Neither your capital nor the tax savings are guaranteed.
2. Make your ISA IHT free
Until recently there was no way to protect ISAs from IHT without losing the tax benefits of tax-free growth and income. It all changed in 2013. New rules have made IHT-free ISAs possible: you can now hold AIM shares in an ISA. Many – not all – qualify for BPR.
But how do you ensure those shares qualify – and continue to qualify – for the relief? Do you have time to research and pick the right stocks? AIM is a market of extremes: some shares perform outstandingly, many poorly.
This is why more and more investors are choosing to transfer their ISA to an AIM Inheritance Tax ISA. That's a portfolio of AIM stocks selected and managed by a professional manager and held in an ISA.
Similarly to IHT portfolios, AIM IHT ISAs invest in small companies. These are generally more volatile and illiquid than larger companies and much higher risk. Neither your capital nor the tax savings are guaranteed.
3. Invest in EIS and SEIS
EIS and SEIS should not be used exclusively as an IHT planning tool. But it’s worth bearing in mind IHT exemption is part of the generous tax package on offer. Like IHT portfolios, EIS and SEIS are high risk and you could get back less than you invest.
Are they for you?
If you are comfortable with investing and the risks, IHT portfolios and AIM ISA portfolios alongside EIS and SEIS investments could be a great way to pass on some of your wealth to your loved ones whilst avoiding the Inheritance Tax trap.
If you have been prudent enough to accrue wealth why succumb right at the end? Unless you do something about it, the government might take 40p of every £1 you’ve worked hard to save over the years.
Please note our service is not advice and the solutions we outline are not the only available. If you are in any doubt you should seek professional advice.