Using IHT mitigation strategies

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Using IHT mitigation strategies

If we think about estate planning, many clients are in older age groups and their ability to replace lost funds is limited, so they are far more vulnerable to volatility. 

Equally the outcome most are looking for is to leave the best possible legacy for their families, while meeting their own life needs. 

But given that the world is in a recession, and liquidity may be tighter, this could reduce the attractiveness of alternative investment market (AIM) shares for Inheritance Tax (IHT) planning, despite the tax advantages remaining in place.

Simon Harryman, investment director at Ingenious says: “The key to this is the delivery of consistently good returns above inflation, not chasing the highest possible growth as the volatility associated is often too damaging.

“Aim is the perfect example of this.

"Since its inception in 1996 the average annual return from the FTSE AIM All share index has been 6 per cent per annum.

"The problem is that this has not been delivered steadily; ranging from -57 per cent to +160 per cent in discrete years.

“£100,000 invested at the end of Q1 1996 would have been worth just £68,996 at the end of Q1 in 2020.

"That’s a reduction of over £30,000 in 25 years, in real terms this would be much worse. Contrast that with an investment which delivers 6 per cent consistently over the same period and £100,000 becomes £404,983.

“Unlisted Business Relief qualifying investments, which are not subject to market sentiment have delivered with much more consistency and lower volatility.”

Shares on AIM can offer an individual the opportunity to pass on wealth without incurring IHT.

"In principle, an investor buys AIM shares which qualify for business property relief (BPR), survives for more than two years, and then passes them on to their children through a will. 

The risks with AIM portfolios

Ian Cook, financial planner at Quilter Private Client Advisers believes that a recession coupled with tighter liquidity could reduce the  attractiveness of AIM or business property relief portfolios.

I feel I would be leaving a client severely exposed if the use of an AIM portfolio was their only means of accessing capital Ian Cook, Quilter Private Client Advisers

Mr Cook explains this is because this type of planning can be unsuitable for clients unaware or unwilling to accept the risk and volatility, and should only form a portion of the financial plan, mainly for capital not required in lifetime, that can be called upon if needed. 

“I feel I would be leaving a client severely exposed if the use of an AIM portfolio was their only means of accessing capital,” Mr Cook adds. 

“The tax advantages and ability for the client to call on their capital are attractive features of this type of portfolio, however I am always mindful that what you may save in tax for your estate, you could potentially lose when markets are as volatile.

“There is also the possibility that legislation could change at any moment, when compared to more established methods of IHT mitigation such as the use of trusts and gifting.

"As we are not accurately able to predict when we are going to pass away, you could feasibly hold this type of portfolio for many years, only to suffer volatility and a change in legislation just before you pass away.”

Tim Morris an adviser at Russell and Co says: “Personally, I like to invest in AIM shares and have seen some already bounce back incredibly quickly. They have become increasingly popular with clients for IHT planning in recent years. 

“Five years ago, I generally wouldn't have dreamed of investing a client in their 70s in these, yet the two-year holding period to qualify for IHT relief is very attractive to many.”

“While AIM shares will remain attractive if they maintain their IHT status and benefit, the recent falls and volatility within investment markets as a whole, and the AIM market in particular, once again bring into focus that any investment into this area should be ‘investment’ led and not just ‘IHT’ led,” Jason Street, senior wealth management consultant at Mattioli Woods, says.

“If a client were to only be investing into the AIM market because of the IHT benefits, they would have been concerned by the volatility seen in this part of the stock market, which is compounded by the wider liquidity issues and lower volume normally traded within the AIM market. 

“While a potential 40 per cent saving of IHT may apply, if investment values fall significantly, this benefit is eroded and some may question whether it is worth the risk.”

AIM shares market cap

Some AIM shares have a market cap equivalent to that of many FTSE 250 companies, yet they like to remain privately owned, Mr Morris says.

Additionally, they often have less bureaucracy holding them back which means they can grow at a rapid rate.

He adds: “There will always be larger potential losses in this space so clients have to be fully aware of that and go into these stocks with their eyes wide open. Now can be a very good time to do so.”

Mr Harryman says: “The majority of AIM shares have fallen sharply in value so they may appear attractive to some and indeed there may be some excellent companies with great long-term prospects for stock pickers. 

“History shows that pandemics are difficult to predict and the recent market volatility could persist for some time. This is far from an ideal environment for those looking to secure their legacy and the risk of a poor outcome is much greater during volatile periods. 

“The pandemic is bringing this issue to the forefront more than ever and we could see that AIM use becomes more restricted to those seeking high growth as their primary objective as opposed to IHT planning.”

When it comes to VCTs and EISs, which encourage investments into early stage, high growth companies, Mr Harryman says these types of investments will be needed “more than ever” in the post-pandemic, post-Brexit world.

The Enterprise Investment Scheme Association (EISA) is lobbying the government to enhance the benefits of EIS to further encourage investments.

Mr Harryman says: “Early stage companies are more vulnerable to economic downturns than established ones so it is important to understand the position of the investee companies, and to review valuations to ensure they are appropriate. 

“Good fund managers will be on top of this but advisers and investors should challenge them to demonstrate this.”

Mr Morris adds: “When it comes to VCTs, I advise on this mainly for clients with limited pension allowance. The tax free dividends are an attractive source of income.

“Due to the higher perceived risk, I tend to only consider EIS for clients looking for IHT planning solutions. Again, the two-year qualifying period is very attractive.

“Plus they tend to have larger portfolios and would not be impacted much by any company failures. And they may even benefit from the loss relief.”