ISAs and inheritance tax
24 January 2021
Having the right kind of investments within this popular investment wrapper can help significantly reduce inheritance tax.
Investors love ISAs, but sometimes they can fall into a trap of believing they are completely tax-free, even when it comes to inheritance tax.
Many investors think that because they’ve benefited from tax-free growth and dividends all their lives, ISAs will automatically be tax-free when they pass away. That’s not the case, and many people get caught out.
Yet clients often don’t want to sell down their ISA investments, even if they understand the inheritance tax liability. ISAs are a key investment for most individuals, and having spent years growing their portfolios, investors get attached to the lifetime tax benefits of the wrapper, even if continuing to hold their investments creates an inheritance tax liability.
For some older clients, this is an important area for consideration. Many believe the only way to reduce an inheritance tax liability is through gifting to beneficiaries, but this requires them to extract wealth from ISAs, meaning they lose access to their wealth and eliminate the possibility of growth.
There is, however, a solution that can help.
Certain investments offer a way to plan for inheritance tax within an ISA, offering advisers an opportunity to move from lifetime financial planning into estate planning.
AIM shares in an ISA
Since 2013, it has been possible to hold Alternative Investment Market (AIM) shares in an ISA. These shares are in companies that sit in a sub-market of the London Stock Exchange and are designed to help smaller businesses access capital from the public market.
Certain AIM-listed companies qualify for Business Property Relief (BPR), which means that after two years their shares should become free from inheritance tax, so long as they are still held on death.
Transferring funds from stocks and shares ISAs into BPR-qualifying AIM shares lets clients keep their ISA pot intact and still target growth, while also planning for inheritance tax.
Like any ISA investment, BPR-qualifying investments are held in the client’s name, so they can access their investment during their lifetime if required, subject to liquidity. Of course, investors will need to be comfortable with the additional risks of investing in smaller companies, which we detail in an example below.
Planning for inheritance tax at an early age
Clients will often consider an AIM ISA investment earlier than some other types of estate planning, such as gifting. At the early stages of planning, the client typically has more appetite for growth and is more concerned about accessing their wealth in the future because they have longer left to live.
A typical client example is Peter, a 65-year-old who is concerned about inheritance tax. He has never married and, as his house alone is worth more than £500,000, he expects his daughter will have to pay 40% inheritance tax on his investments when he dies. This includes the ISA investments he’s been building up over the years.
Peter talks to his financial adviser, who suggests investing in an AIM Inheritance Tax ISA, which comes with the same tax benefits his ISAs have always enjoyed, but after two years becomes free from inheritance tax, assuming it is still held at the time of death. It also offers access to the growth potential of carefully selected UK smaller companies.
Along with the benefits, however, he must also consider the risks.
The value of the investment, and any income from it, can fall as well as rise. He may not get back the full amount he invests. The shares of AIM-listed companies could fall or rise in value more than shares listed on the main market of the London Stock Exchange. They may also be harder to sell.
Tax treatment depends on individual circumstances and tax rules could change in the future. Tax relief depends on portfolio companies maintaining their qualifying status.
An ISA portfolio of BPR-qualifying shares
An AIM Inheritance Tax ISA is often an adviser’s first experience of BPR-qualifying investments. We know this from working with advisers for years.
It’s common for clients to have accumulated large ISA pots that have a potential inheritance tax liability. So the concept of an inheritance tax-efficient ISA can be a compelling one for a number of suitable clients.
Clients are used to making investments. They are used to ISAs. They are not used to gifting or giving money away. And so, that makes this is a far easier conversation for many clients.
Often clients will be comfortable with the planning because they’re transferring funds from an existing stocks and shares ISA, where there is already some appetite for risk. And because the client keeps their ISA wrapper as part of the planning.
It is important to understand, however, that not all AIM shares will qualify for BPR. It is also a high-risk area where companies can fail, and this is why investors often steer towards specialist managers to create ISA portfolios for them, such as the Octopus AIM Inheritance Tax ISA.
Some of our fund managers have been investing on AIM since it began 25 years ago. It is a great market for growth and we are one of the largest and most experienced investors.
Join our AIM Inheritance Tax ISA webinar to find out more about how it works, who it’s for and how our service is managed. Sign up here: octopusinvestments.com/isa-inheritance-tax/
An Octopus AIM Inheritance Tax ISA is likely to be higher risk than more mainstream stocks and shares ISAs. BPR-qualifying investments are not suitable for everyone. Any recommendation should be based on a holistic review of your client’s financial situation, objectives and needs. We do not offer investment or tax advice. Issued by Octopus Investments Limited, which is authorised and regulated by the Financial Conduct Authority. Registered office: 33 Holborn, London, EC1N 2HT. Registered in England and Wales No. 03942880. Issued: January 2021. CAM010614.
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