Balancing act: A record number of families are being stabbed with inheritance tax bills
Record numbers of families are being stung with inheritance tax bills, figures from the Tax and Customs Administration revealed last week. More than £7.1bn in such estate taxes were paid last year – £1bn more than the year before.
The number of families forced to pay death taxes rose 24 percent in the past year to 41,000. “It’s not a burden on the rich anymore,” said Helen Morrissey, head of pension analysis at Hargreaves Lansdown wealth platform. ‘Inheritance tax deductions have been frozen since 2009, dragging more and more families into her job.’
The easiest way to reduce your estate tax bill, if any, is to give—or spend—money away to loved ones during your lifetime.
However, there are also ways to invest that can help you keep your money, protect it from estate taxes – and even grow your wealth.
Your estate is subject to inheritance tax if it is worth more than £325,000 – or £650,000 for a couple. You also have an additional allowance of £175,000 if you pass on a family home to your descendants.
Investing in small businesses can help
If you buy shares listed on the Alternative Investment Market (AIM), they will be free of inheritance tax after two years.
Invest successfully and the savings can be huge as any assets above estate tax are thrown around with a 40 percent tax bill. However, the inheritance tax benefit is a reward for taking significant risks by investing in small, often untested UK public companies.
Therefore, this approach is only suitable for experienced investors who understand the risks and can afford to lose money if they fail.
AIM is the London Stock Exchange’s stock exchange for small and medium-sized companies in their growth phase. Inevitably, these companies are much riskier to invest in than companies that have been around for a long time.
They are more likely to go bankrupt or see their values plummet. For example, the share price of AIM-listed outsourcing group iEnergizer collapsed last week when it announced it would be delisted. That will have resulted in some investors suffering losses and not being able to trade their shares as easily.
But because they are still in their infancy, AIM companies will grow faster.
Successful examples are well-known names such as clothing group Asos, airline Jet2 and luxury tonic water company FeverTree. If you had invested in their early stages, you would have made impressive returns. If you had invested £1,000 in FeverTree in 2014, it would be worth £7,438 now.
“AIM stocks can be much riskier and more volatile than other stocks and assets,” warns Alice Guy, head of retirement and savings at investment platform Interactive Investor. “You could end up saving taxes but missing out on investment growth, especially if you’re not diversified.”
Alex Davies, CEO and founder of the tax-friendly investment service Wealth Club, warns that AIM investments can be hard to sell and it is difficult to build a well-diversified portfolio of AIM stocks to spread your risk because there are a limited number 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 means that control is not what you might find elsewhere,” he adds. ‘Over the years, this has led to a number of scandals, in which companies have collapsed or become victims of fraud.’
Davies believes that making AIM investing a success isn’t so much about choosing superstar companies, but more about avoiding terrible investments so that your potential estate tax savings aren’t wiped out by poor share price performance.
How do the tax benefits work?
Investing in AIM stock is one of the quickest ways to lower your estate taxes, says Mike Stimpson, a partner at asset manager Saltus. “It can provide 100 percent inheritance tax exemption, saving you up to 40 percent in tax.”
You can also hold AIM Shares in your Personal Savings Account where they are also protected against income tax, capital gains tax and stamp duty.
Not all AIM stocks are eligible. If an AIM company is listed on a recognized foreign stock exchange or invests primarily in real estate or stocks, it is not eligible.
The tax credit is also lost if the company is delisted from AIM and moves to the main market or if the company is acquired. Funds that invest in AIM shares also do not qualify for the exemption, as the shares must be held directly.
Shares are eligible only if they qualify for Business Property Relief. This was a tax benefit introduced in 1976 to transfer family businesses from generation to generation free of inheritance tax.
Over the years, its scope has broadened and most AIM stocks are now eligible, but you should check before investing.
Ask the experts to help with planning
Many will find it safer and easier to hire an expert to manage their AIM IHT portfolio. Investors can purchase an entire portfolio, including a number of eligible stocks, selected by a fund manager.
Many of these portfolios have underperformed over the past year, even though they have outperformed the AIM market as a whole.
This shows how important it is to understand the risks, but also with significantly lower prices, it can be easier to find a bargain than in the past. Jason Hollands, managing director at investment group Bestinvest, says it’s always best to call in an expert to get a tax break.
‘The status of a company can change. Therefore, for anyone considering AIM portfolios, it would be wise to hire a professional manager rather than do it yourself,” he says.
“I would encourage people considering an AIM portfolio to think more broadly about ways to reduce IHT and to consider financial planning advice.”
Other tactics that can help lower tax bills
There are a number of other ways to lower your family’s estate taxes. Other early-stage investments, such as Enterprise Investment Schemes and Seed Enterprise Investment Schemes, offer inheritance tax but carry 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 in a pension are automatically exempt from inheritance tax if you die before the age of 75. After that, everyone who inherits your pension will be taxed at the income tax rate.
Jonathon Marchant, fund manager at asset manager Mattioli Woods, adds: “AIM stocks can play a role in reducing liabilities. But while we know that AIM has spawned and continues to provide access to some great companies, it should be seen as part of a broader, diversified investment portfolio.”
Some links in this article may be affiliate links. If you click on it, we may earn a small commission. That helps us fund This Is Money and use it for free. We do not write articles to promote products. We do not allow any commercial relationship to compromise our editorial independence.