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How to avoid IHT using Aim

Bespoke Aim funds could save your estate thousands in inheritance tax (IHT). But are they worth the risk and the high fees?
October 16, 2013

Alternative Investment Market (Aim) shares have mushroomed in popularity since August when the Treasury opened the door to let them into individual savings accounts (Isas). But many private investors are baffled by the key that unlocks inheritance tax relief (IHT) from Aim - Business Property Relief (BPR). Those who want to take advantage have two options: either swot up or pay someone else to.

The Aim market has had more than its fair share of detractors over the years, but a steady stream of promising news has been flowing out of the sector this year, and the Aim 50 index is up by around 50 per cent over the period. Aim is under-researched and under-brokered, which provides great opportunities - if you have the time and research capacity.

But for investors buying a unit trust or investment trust that focuses on investing in Aim shares, the spectre of inheritance tax still looms because these investment vehicles do not benefit from IHT relief. So if your primary reason for investing in Aim is to minimise your IHT bill, these are off the menu.

When held directly, though, a number of Aim shares can protect your estate from the taxman when you die, but the rules surrounding this are complex, meaning self-directed investors need to do a lot of homework if they want to be sure their shares qualify.

For investors who want the certainty without the hassle, there are some managed Aim funds that can take a lot of the hard work away - but you have to be willing to pay a substantial fee. If you are, then after holding them for just two years, they will be IHT free. This makes them a quick fix compared with other IHT reducing solutions, such as gifting assets (called a Potentially Exempt Transfer), which takes seven years to be wiped off your estate for tax purposes.

But are the fees and the risks of Aim worth the speedy IHT relief and ease of these schemes? Here we take a closer look at exactly what they could do for you.

 

What do managed portfolios look like?

Managed Aim funds are unique portfolios of, usually, 15 or more shares (ideally 20 or more) that are tailored to your individual investment profile and goals. This is a major plus point, but it also means they are extremely difficult to compare because a manager could easily have some portfolios that are performing very well, at the same time as having some that are going down the drain. Since investment returns are arguably the most important factor when choosing a manager, this can prove problematic for investors trying to choose a manager.

And Aim shares are so volatile that it is very difficult to track performance. David Smith, financial planner at Bestinvest, says it is important to ascertain what the investment track record of the manager is, not just the company he or she is working for.

 

How do they reduce your IHT bill?

The managers of Aim funds work by making sure every share picked qualifies for BPR, a form of tax relief some shares qualify for but others don't - and it can be difficult for ordinary investors to tell the difference. Once you have held Aim shares that qualify for BPR for two years, they will sit outside your estate and their full value will be IHT exempt.

So what exactly is BPR? Introduced in 1976, it's a tax relief provided by the UK government as an incentive for investing in small and growing trading businesses. Investors in unquoted shares of qualifying trading companies benefit from 100 per cent relief from inheritance tax, provided the shares are held for two years and are held at the time they die.

But it can be difficult to tell whether companies qualify for BPR, and whether they do or don't can change suddenly. As a result, DIY investors holding individual shares risk being caught out. But managed Aim funds employ teams of tax experts who actively check each and every share you own will qualify.

 

Broadly, a company won't qualify for BPR if:

■ The business or company mainly deals with securities, stocks or shares, land or buildings, or in making or holding investments;

■ The business is a not-for-profit organisation;

■ The business is subject to a contract for sale, unless the sale is to a company that will carry on the business and you will be paid wholly or mainly in shares of the acquiring business;

■ The company is being wound up, unless this is part of a process to enable the business of the company to carry on.

And you can't claim Business Relief on a business asset if the asset:

■ Also qualifies for Agricultural Relief;

■ Was not used mainly for business in the two years immediately before you passed it on as a gift during your life, or as part of your will;

■ Is not required for future use in the business.

But BPR is applied by looking backwards at companies to see what they've done - so suddenly a company that qualified may not anymore. For example, if a company sold an office for £26m and made a £10m profit on it, anyone who dies holding shares in the company in the same tax year will not qualify for full BPR because the company made profits which came from the sale of a property. This is why it's such a complicated business, and why some people decide to pay a manager to sort it out for them.

 

You need a lot of spare cash

For most managed Aim funds you need to invest a minimum amount ranging from £25,000 to £100,000. If you have a relatively small amount available to invest you will find it harder to find a manager that will take you on board, and because the minimum investment is so high, advisers recommend you need to have at least £1m in liquid assets overall to go for products such as this, because Aim is highly risky and you need to be able to afford to lose money in case your investments don't do well.

You also have to be willing to fork out for the charges, but if you end up significantly reducing your IHT bill, it could be well worth it. Initial charges are typically between 2 and 5 per cent, while annual charges typically range from 1.5 to 2 per cent a year, although you need to check whether the manager also levies additional charges such as dealing/custody fees.

 

Be prepared for losses or to pay for protection

Aim is a very volatile market which means it's easy to lose money. If your prime objective for investing in a discretionary managed Aim portfolio is ensuring the portfolio will fall outside your estate when you die, after holding it for two years or more, you could select an Aim manager that incorporates downside protection. This means that the manager takes out an insurance policy on your life that will make-up any losses that may result on death, usually up to 20 per cent.

Only a handful of Aim fund managers offer such protection, and you should read the small print closely as the terms and conditions of the downward protection might differ from product to product. Some will insist on medical underwriting, while others won't ask for it. And some charge for the insurance policy (an additional 2 per cent a year isn't unusual), while others won't charge you a penny for the privilege. Stellar Aim IHT portfolio management charge an additional fee of 2.15 per cent per annum for this cover, and investors have to answer a few health questions to get it. Downing Aim IHT portfolios also offer the service but they don't ask you any health questions. And on top of this, some offer open-ended cover, while others will only offer cover to a certain age, commonly 85 is the upper ceiling. Mr Smith says people who invest in Aim portfolios are usually aggressive in terms of their risk profile, so protection isn't their prime concern.

As such, Mr Smith's preferred manager is Canaccord Genuity Inheritance Tax Portfolio Service, which doesn't offer a downside protection option. It's an investment house with a good selection of highly experienced Aim managers, though. Collins Stewart picks stocks across a variety of sectors and on a conservative basis, looking for medium- to long-term potential. Once you've bought the portfolio, the company will let you transfer it to your spouse without restarting the qualifying period - which is a useful feature. However, the minimum investment is £100,000, which means the service will be out of reach for investors who cannot afford to allocate a sensible portion of their total estate to it.

 

 

If Aim is just too risky

Ordinary managed Aim portfolios aren't for the faint hearted. Investors looking to use BPR to mitigate inheritance tax are normally towards the older end of the spectrum, and the older you are, the more risk averse you generally become.

As a result, Aim portfolios are often just too risky. If you'd like to reduce your IHT bill quickly but would prefer a scheme that provides more transparent, lower-risk returns, there are some inheritance tax services that could fit the bill.

These inheritance tax schemes work in the same way as managed Aim funds in that they qualify for BPR (meaning the full value of your investment will be free from IHT after two years). But they aim to provide capital security, transparent returns and access to capital if required. Typically, they invest in asset-backed finance and operate a portfolio of secured loans, the profits of which they return as a yield to investors (although they normally offer an accumulation option, too). You can expect a yield of a least 3 per cent from these schemes.

As a result, the risks associated with these schemes are much tamer than Aim portfolios, but don't forget your money is still invested in unlisted companies - which are by no means 'a safe bet'. For example, some invest in the production of TV programmes and films, which provide highly visible earnings and aim for growth that beats the Bank's base rate by 1 to 2 per cent. Mr Smith recommends the Octopus Inheritance Tax Service (3 per cent targeted return), Rockpool's Managed Inheritance tax (5 per cent targeted return) service and the Puma Heritage Scheme (3 per cent targeted return).

And there are some others that invest in renewable energy, a sector that produces reliable income due to the associated contracted and subsidised earnings. Earnings as high as 5 to 7.5 per cent a year are often associated with these investments. Downing runs a scheme which invests in both asset-backed and renewable energy businesses. The plan also has the benefit of 20 per cent downside protection up until age 85, which could be a good bet if you're looking for a safer option.

 

CONTACTS:

Downing

Tel: 020 7416 7780

http://www.downing.co.uk/

Puma

Tel: 0207 408 4100

http://www.pumainvestments.co.uk

Rockpool

Tel: 020 7015 2150

http://www.rockpool.uk.com/inheritance-service/

Octopus

Tel: 0800 316 2295

http://www.octopusinvestments.com

Canaccord Genuity

Tel: O20 7523 4600

www.canaccord.com/uk

Bestinvest

Tel: 020 7189 2400

http://www.bestinvest.co.uk