Investing in Aim stocks can mitigate inheritance tax

However, there are a number of ways in which you reduce your estate's IHT bill. These include investing in Alternative Investment Market (Aim) shares, some of which are eligible for business property relief (BPR), which means they can fall outside your taxable estate.

The Aim market mainly consists of smaller and newer businesses so it can also provide tremendous growth opportunities. And this month also saw the fifth anniversary since Aim shares became eligible for inclusion in an individual savings account (Isa). So money has been flowing into this market from both those seeking potentially higher returns from smaller companies and those seeking to reduce IHT as rising property prices push estates over the IHT threshold. 

Mike Horseman, managing director at Cockburn Lucas, says he is increasingly allocating part of his clients' Isas to a professionally-run Aim Isa. "That means you get to keep the tax efficiency of the Isa but with the IHT kicker," he says.

The number of products that facilitate this has also grown. Investors, either directly or via a financial adviser, can purchase Aim Isas or Aim investment accounts from providers who ensure each stock meets the necessary criteria to mitigate IHT.

However, Aim is also higher risk and investing in this area could result in significant losses. Over most long-term time periods the FTSE Aim All-Share index has not outperformed the FTSE All-Share index. For example, over 10 years and 15 years the FTSE All-Share has made 122 per cent and 252 per cent respectively. But the FTSE Aim All-Share index has made 49 per cent and 88 per cent over those periods, respectively.

So even though there is an increasing need to mitigate IHT, investors should think very carefully before plunging into Aim.

How to get tax relief

To be qualify for BPR, Aim shares have to meet strict and often unfathomable criteria. If they want to mitigate IHT, investors have to hold BPR-qualifying Aim shares at the time of their death, and have held BPR-qualifying shares for at least two years in the previous five years before their death.

This does not mean you need to own the same Aim stocks for two years before your death. For example, you could have held £100,000 worth of BPR-qualifying shares for 1.5 years, sold them, and bought another £100,000 worth of qualifying shares six months before your death.

This would mitigate IHT if done within five years of your death, and when your heirs claimed IHT relief on the £100,000 during probate it would not fall within your estate.

However, working out which companies qualify for BPR is easier said than done. Currently around 820 of the 1,200 stocks listed on Aim qualify for BPR, but the list constantly changes. There is guidance available from HMRC on which types of companies qualify at www.gov.uk/business-relief-inheritance-tax/what-qualifies-for-business-relief.

Ben Yearsley, a director at advice firm Shore Financial Planning, says: "There's a lot of flexibility in the rules but often a lot of uncertainty. Also, if a company qualifies for BPR today, that does not mean it will tomorrow."

Mr Horseman says he would not put more than 15 per cent of a client's assets into an Aim Isa, but would allocate more to other forms of products that are IHT exempt because they qualify for BPR, such as Enterprise Investment Schemes (EIS). These have to meet different criteria to mitigate IHT.

Valuations and government interference

Since Aim stocks have been eligible for Isas this market has outperformed the wider UK market. Over the last five years the FTSE Aim All-Share index returned 61 per cent against 42 per cent for the FTSE All-Share index. But there is a risk that this is being driven by the IHT benefits rather than the fundamental valuations of Aim companies.

"I have stopped people putting more of their IHT portfolios into Aim," says Mr Yearsley. "I am worried about valuations. All the Aim IHT managers are chasing the same companies – ones that qualify and companies they like."

Ready-made Aim IHT Isas hold between 25 and 40 stocks so are relatively concentrated. This suggests that there is a limited number of fundamentally strong businesses that offer BPR benefits creating th risk of high demand and overvalued stocks. Aim also tends to be very illiquid meaning that investors who allocate via an Isa or investment account may not be able to redeem their investments immediately, or have to sell at an unfavourable price.

Mr Yearsley adds that there are a number of other ways to mitigate IHT such as EIS and offshore bonds. 

"If you want to invest in Aim for IHT benefits then fine, but the next question should be is it worth it?" says Mr Yearsley. "There is no point saving 40 per cent tax if your investment halves."

The Office for Tax Simplification, meanwhile, is looking to simplify IHT rules. The rules on BPR date back to 1976 and were created to allow family-owned businesses to be passed onto children without incurring IHT. "These rules are not being flouted, but they are being exploited," says Mr Yearsley.

So there could be changes in terms of what qualifies for BPR and the length of the qualifying period, which would also change the way in which Aim IHT products work. But it is not expected that the government will abolish BPR as this would cause havoc for Aim stocks.

Limited access and high costs

Running your own IHT Aim portfolio is difficult. The stock-specific rules can be complicated, time consuming, and you cannot be sure that your shares will get IHT relief until your estate is in probate. 

There are not many ready made Aim IHT portfolios available to buy directly – many of these need to be purchased via an intermediary such as a financial adviser. The managers of Aim IHT-focused portfolios don't just put together a portfolio of shares with good growth prospects – like with a conventional fund – but also have to ensure the portfolio is always IHT-efficient, hence the smaller number of options.

Aim IHT Isa products are available from Blankstone Sington, Octopus, Unicorn, Puma and Stellar. These providers, with the exception of Stellar, also offer Aim IHT portfolios outside Isas. 

However, these products are not cheap. Their annual management charges, which do not include the transaction costs, range between 1.25 per cent and 2 per cent. They also have initial charges of between 0.75 per cent and 4.5 per cent.

There are more options from companies including Charles Stanley, Investec Wealth and Quilter. You either need to be a client of these companies, or of an adviser who uses their wealth management business and pay his or her fee on top of this.

Mr Horseman uses Unicorn's IHT service for his clients and says fees can be above 2 per cent.

"I agree this is a lot, but it is still less than many multi-asset funds charge or the total cost of investing via a discretionary fund manager," he says. "The expertise needed in this market justifies the fee, however, I accept there is always room for improvements. The tax breaks of 40 per cent on IHT and tax efficiency of an Isa go some way towards sweetening the pill."

Off the shelf Aim IHT products

Source: WealthClub