What is Inheritance Tax?
The money or assets a person leaves behind when they die, minus any debts, is known as their ‘estate’. If the estate is worth more than £325,000, the current threshold or ‘nil rate band’, plus any additional 'residence nil rate band', Inheritance Tax (IHT) of 40% applies to the excess.
What is the Inheritance Tax threshold or ‘nil rate band’?
The IHT threshold or ‘nil rate band’ is the maximum value of assets you can pass on tax free.
It is currently set at £325,000, and doubles to £650,000 for married couples and civil partnerships. Even if one dies, the surviving spouse can inherit any unused additional allowance.
What is the ‘residence nil rate band’?
From April 2017 a new IHT exemption is available on your family home. It starts at £100,000 per person in 2017/18 and increases by £25,000 each year until it reaches £175,00 in April 2020. This opens up the possibility that a married couple or civil partnership could have a total £1m allowance between them.
In the Summer Budget of 2015 George Osborne announced inheritance tax will be gradually reduced on main residences from 2017, until it's totally scrapped on homes worth up to £1 million for married couples (£500,000 for singles) in 2020.
However, the new tax-free residence allowance will only apply when the beneficiary is a direct descendant (children, step-children and grandchildren).
It will also be tapered for properties worth £2 million or more: homeowners will lose £1 of the 'main residence allowance’ for every £2 of value above £2 million, until it's totally lost for properties worth £2,350,000 or more.
What are the options to protect my estate from IHT?
There are many ways to legitimately reduce the size of an estate for inheritance tax purposes. The most traditional is gifting assets. What many people do not like about this is that it entails completely giving up control of those assets.
An alternative is to establish a trust – a more complex option that allows you to retain some control over the assets until they’re distributed to the beneficiaries.
However, to benefit from full IHT exemption through gifts or trusts, you must live for at least a further seven years.
A quicker and more flexible option, which is growing in popularity, is investment into companies that benefit from Business Property Relief (BPR). This allows you to retain full control of your assets. You can receive an income or make capital withdrawals if necessary (although any money you take out will fall back into your estate). You qualify for full IHT exemption only two years after making the investment. If an investor dies during the two-year period, the investment can be passed to the spouse or civil partner without the two-year clock resetting.
There is one significant risk though. As BPR-qualifying companies are small companies, your capital is at risk, even more so than with other investments. That said, when you invest in BPR-qualifying companies through a managed portfolio, or IHT portfolio, that risk is spread across a number of companies. Some IHT portfolios are specifically designed with the aim to preserve capital, however this is never guaranteed.
What is Business Property Relief?
Business property relief (BPR) was originally introduced to allow entrepreneurs to pass their small business down through generations without incurring an IHT liability.
The scope of BPR is now wider, so it is possible to benefit from the IHT exemption even if you’re not the business owner, but simply an investor in a BPR-qualifying company.
What companies qualify for BPR?
Mainly private unquoted businesses qualify for BPR. Many smaller companies listed on the AIM also qualify, and therefore potentially fall outside of an estate for IHT purposes.
The qualifying rules are complex and cannot be covered here in full - an IHT planning specialist will be able to help. Notably, companies that deal in stocks and shares, land or buildings are excluded. All businesses must be involved in a trade; they cannot just be an investment company.
What is an IHT Portfolio?
An IHT portfolio is effectively a managed portfolio of companies that qualify for BPR.
IHT portfolios come in two varieties: those that invest in AIM-listed companies (held inside or outside an ISA) and those that invest in unquoted companies (cannot be held inside an ISA). The latter type tends to invest in asset-backed businesses that give a degree of stability to the portfolio. AIM-listed businesses are often those with steady cash flows, predictable revenue streams and profits.
However, it’s important to note with all IHT portfolios your capital is at risk and not guaranteed.
What are the tax breaks?
You can benefit from full IHT exemption on the amount you invest – a saving of 40% - provided you hold the investment for at least two years.
How much can I invest?
There is no maximum. Unlike other ways of mitigating IHT, such as trusts, you retain full control of your assets throughout.
How do I claim my tax reliefs?
There is nothing to actually claim. Investments in BPR-qualifying companies and IHT portfolios fall outside of your estate after you’ve held for at least two years.
How do I invest?
Visit the offers page for a list of opportunities available. The two-year clock starts ticking once funds have been invested.
Can I combine inheritance tax portfolios with other tax reliefs?
IHT-exempt investments typically offer other forms of tax relief. For example, AIM shares held in an ISA benefit from the usual ISA reliefs – tax-free income and tax-free growth, but also qualify for IHT relief if they are held for two years. EIS or SEIS investments offer income and capital tax relief, loss relief and tax-free growth, but also qualify for IHT-free status after the two-year minimum holding period.
What are the charges?
The charges vary by product, and often include an initial charge as well as annual management fees.
Who are IHT portfolios for?
IHT products are for investors whose estates are large enough to be affected by inheritance tax and who want to keep control of their assets. The type of portfolio chosen depends on many factors, including attitude to risk and whether income is needed. If in doubt, always seek professional advice.
Can I sell my Inheritance Tax portfolio?
One of the major advantages of investing in IHT portfolios over other IHT-planning strategies is the degree of control you can retain. For instance, if your circumstances were to change, it is possible to request the funds. Of course, in this case, you would however lose the IHT exemption.
What are the key risks?
As with all investments, your capital is at risk and not guaranteed.
But because IHT portfolios invest in small companies, the risk is usually greater than with other stock market investments. Small companies are more volatile and more likely to fail than their larger counterparts.
That said, IHT portfolios try to mitigate this by spreading the risk across a selection of BPR-qualifying companies. Many also aim for capital preservation, thereby investing in asset-backed businesses that give a degree of stability to the portfolio or AIM-listed businesses with steady cash flows and predictable revenue streams and profits.
IHT portfolios are intended for the long term, but give you the option to request the funds if need be. It’s important to remember though BPR investments are less liquid than other stock market investments. They will be harder to sell.
Just to repeat: to qualify for IHT exemption, you must hold the investment for a minimum period of two years and hold it on death – and the investments must remain qualifying.
Please remember, all the tax and product rules mentioned here are those currently applying but could change in future.