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.