Investing in Alternative Investment Market (Aim) shares is but one way to avoid inheritance tax (IHT). It is a strategy that can be difficult to get right and not everyone agrees that it is the best way to proceed. Investors Chronicle's Chris Dillow argued in a recent reader portfolio review: "There's no point, in a free market, buying an asset merely because it has a tax advantage. This advantage should be offset by lower pre-tax returns. In other words, there's no point holding Aim shares simply to avoid IHT. You pay for this tax break in the form of lower pre-tax returns."
So make sure that you have considered all the options to beat inheritance tax. These may include rewriting your will to redirect assets (this can be done after your death by deed of variation), using discretionary trusts to shelter assets or equity release to unlock wealth tied up in the family home. However, these are two of the simplest options:
1) Give it away while you are alive
While you might like the thought of leaving a legacy after you die, it can pay to be generous while you are alive. One of the simplest things you can do to avoid paying IHT is to spend or give away part of your wealth during your lifetime. The benefit of this is you can witness your heirs enjoying your money.
Any gifts you make to individuals will be exempt from IHT as long as you live for seven years after making the gift. These sorts of gifts are known as 'Potentially Exempt Transfers' (PETs). If you die between three and seven years after making a gift, and the total value of gifts that you made is over the threshold, any IHT due on the gift is reduced on a sliding scale. This is known as 'taper relief'.
In addition to PETs, several types of gift you can make during your lifetime are completely free of IHT:
You can give away gifts worth up to £3,000 in total in each tax year. You can carry forward any unused part of the £3,000 exemption to the following year, but if you don't use it in that year, the carried-over exemption expires.
Wedding or civil partnership ceremony gifts are exempt from IHT, subject to certain limits: parents can each give cash or gifts worth £5,000, grandparents and great grandparents can each give cash or gifts worth £2,500, plus anyone else can give cash or gifts worth £1,000.
You can make small gifts up to the value of £250 to as many individuals as you like in any one tax year.
Any regular gifts you make out of your after-tax income, not including your capital, are exempt from IHT. These gifts will only qualify if you have enough income left after making them to maintain your normal lifestyle.
2) Take out insurance
If you can't beat an IHT bill, you can insure against it. This is one of the simplest ways of covering an unwelcome bill, but unless you are relatively young and healthy, the cost may be high.
You take out an insurance policy called a 'whole of life' policy that will pay out enough to cover the IHT bill. The policy is written under trust for your heirs. Because the policy is written under trust, it is paid out free of IHT and before probate is granted, so your heirs can pay the tax bill as soon as it’s due. The insurance company will provide the trust form.
Her Majesty's Revenue & Customs (HMRC) treats the premiums paid to the insurance policy as a lifetime gift if you pay them yourself, but these can usually be covered by one of the tax-free exemptions - either the annual £3,000 exemption or the 'gifts out of normal income' exemption.
There is no doubt that IHT planning is complex, and if you are in any doubt about how to proceed, you should take independent financial advice specific to your individual and family circumstances. You can search for an independent financial adviser in your area who specialises in IHT planning by using our Find an IFA service.
