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9th July 2024

Most investors value the tax-free growth and income provided by their ISAs, but many are not aware of the Inheritance Tax (IHT) their families will have to pay on these investments when they die.

What is Inheritance Tax (IHT)

Inheritance Tax (IHT) is paid on the money and possessions that you leave to your beneficiaries when you die. The first £325,000 of your assets are free from IHT (this is often called the ‘nil-rate band’ - NRB), but everything over this level is taxed at 40%. The current NRB of £325,000 is expected to remain frozen until 2028.

In April 2017, the UK Government introduced a new Inheritance Tax (IHT) allowance known as the Residence Nil-Rate Band. This allowance can be claimed if your children or grandchildren inherit your home or an equivalent amount from your estate. It offers an additional threshold of £175,000, which can be used to reduce the value of your estate for Inheritance Tax purposes.

It is possible to estimate your IHT liability in advance based on the current rules, tax rates, allowances and value of your estate and put in place life assurance to pay the liability when it arises but age and health will be a factor as to whether this is viable. So what could you do to reduce the IHT bill?

Reducing your IHT bill

There are a number of well-established ways to reduce or potentially even eliminate the amount of IHT your loved ones are required to pay. Some people choose to SKI (spend the kid’s inheritance) and this can be a fun way you enjoy your own money but there are other options. Examples include making financial gifts (including charitable gifts now or as a bequest) and you may prefer to “give with a warm hand rather than a cold one”. You can use trusts and investments that qualify for Business Property Relief (BPR), which is an established form of tax relief that gives people an incentive to invest their money into trading businesses. It was introduced in 1976 as a way to ensure that IHT wasn’t paid on small businesses.

The Alternative Investment Market (AIM)

The AIM is the London Stock Exchange's international market for small companies.

In 2013, the Government changed the rules to allow AIM-listed shares, which can be BPR qualifying to be held in an ISA. AIM is the London Stock Exchange's international market for small companies. A wide range of businesses, including early stage, venture capital backed, as well as more established companies, join AIM seeking capital to fund growth.

The Alternative Investment Market is home to many small, dynamic businesses with significant growth potential. Any profits would be tax-free in an ISA, but they can be very volatile with a high risk of failure. They should only be considered by sophisticated investors who have a long-term investment horizon, understand the risks and can accept falls in the value of their investment.

Certain AIM shares benefit from BPR which provides an IHT exemption once the shares have been held for two years. Therefore, investors holding these shares in their ISA for the two-year qualifying period should benefit from virtually no taxes while they hold the share, and no potential IHT liability providing the investment continues to qualify.

Remember you should always consider the investment merits first and look at the tax benefits as an added bonus, not a reason to invest especially as AIM investing carries more risk of investment loss.

What are the key benefits of an Alternative Investment Market Inheritance tax ISA?

  • Most ISAs are subject to inheritance tax when you die. On the other hand, AIM Inheritance Tax ISA is exempt from inheritance tax; therefore, your beneficiaries will not be left with an IHT bill of 40% of the investment
  • Most forms of estate planning (such as gifts or simple trusts) take seven years to become fully exempt from IHT. An AIM IHT ISA takes just two (although you must be still holding the investments when you die and they must continue to qualify for BPR).
  • No complex legal structures, no underwriting and no medical questionnaires to complete.
  • Access withdrawals whenever you want. There's an option to set up regular withdrawals if you ever need to supplement your income. Although, remember, that if you have already used your ISA allowance for the current tax year, you won’t be able to put any money you withdraw back into your ISA, and any amounts you withdraw, if they’re not spent, will form part of your estate for IHT purposes.
  • Potential for tax-free growth and dividends - as you’ll be investing in an ISA, you’ll pay no income tax on the dividends paid by the companies in your portfolio. You’ll also pay no Capital Gains Tax (CGT) on your returns and you do not have to declare ISAs on your tax return.

What are the risks of an Alternative Investment Market Inheritance tax ISA?

  • The value of your investment can go up or down and you may not get back the full amount invested. Investing in AIM-listed shares normally involves more risk than investing in shares of companies listed on the main market of the London Stock Exchange.
  • Your investment could experience volatility. The performance of AIM-listed shares tends to be more volatile, which means their value can rise or fall by greater amounts on a day-to-day basis.
  • Tax relief cannot be guaranteed. The benefit of tax relief depends on the individual circumstances of each investor. Tax rules could change in future, and the availability of tax relief also depends on the companies we invest in maintaining their qualifying status, which is assessed at the point a claim for the relief is made.
  • Your investment could take longer to sell than expected. Shares in AIM companies are not as easy to buy or sell as shares listed on the main market of the London Stock Exchange. This means that the availability and timing of withdrawals cannot be guaranteed.

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Important Information

Past performance is not a guide to future performance and may not be repeated. Investment involves risk.

The value of investments and the income from them may go down as well as up and investors may not get back any of the amount originally invested. Because of this, an investor is not certain to make a profit on an investment and may lose money. Exchange rate changes may cause the value of overseas investments to rise or fall.

This communication is for information purposes only and is based on our understanding of current UK tax legislation and HM Revenue and Customs (“HMRC”).  Levels and bases of taxation and reliefs are subject to change and their value to you will depend on your personal circumstances. Nothing in this communication constitutes financial, professional or investment advice or a personal recommendation. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.

Any opinions expressed in this document are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or companies within the same group as Ascot Lloyd as a result of using different assumptions and criteria.

The FCA does not regulate wills, estate and inheritance tax planning.

This communication is issued by Capital Professional Limited, trading as Ascot Lloyd.  Ground Floor Reading Bridge House, George Street, Reading, England, RG1 8LS.  Capital Professional Limited is registered in England and Wales (number 07584487) and is authorised and regulated by the Financial Conduct Authority (FRN: 578614).