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Aiming high in a world of low returns

Paul Latham

Browbeaten cash Isa customers deserve a break.

As far as I can see it, there are three problems for cash Isa customers at the moment. First, many of them are staring into the abyss of close to zero returns.

That’s certainly the case if you’re instant cash Isa customer of NatWest and RBS, which announced in early September that they are paying just 0.01 per cent interest. And with the Bank of England cutting the base rate to 0.25 per cent in August, the low interest rate world appears set to continue.

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Second, since the Personal Savings Allowance came into effect in April, the first £1,000 of interest earned by basic rate tax-payer is now tax-free anyway.

Even higher-rate taxpayers can earn £500 interest with no tax. So while years of low interest rates might have been sweetened by the tax-free status of an ISA, it no longer holds the attraction that it once did.

Which brings us onto problem number three. Namely, that it still doesn’t seem to be common knowledge that Isas are subject to inheritance tax.

Sure, Isa investments can grow free of capital gains tax and offer other valuable benefits during a person’s lifetime. But one of the downsides is that the £100,000 Isa set aside for the kids could unintentionally burden them with a £40,000 inheritance bill.

Happy birthday AIM Isa

For these three problems there is one potential solution: investing in shares listed on the Alternative Investment Market (AIM) within an Isa. It was back in 2013 that the government allowed shares listed on AIM to be included in stocks and shares Isas – so the AIM Isa recently celebrated its third birthday.

Investing in AIM-listed stocks that are expected to qualify for Business Property Relief (BPR) means investors can undertake inheritance tax planning within an Isa wrapper. As long as they have been held for at least two years upon the investor’s death, shares that qualify for BPR can be left to beneficiaries free from inheritance tax.

It’s an option that’s likely to appeal to Isa customers looking for growth. It offers the familiar framework of an ISA – investors pay no capital gains tax on shares nor income tax on dividends – while encouraging their investment to work considerably harder.

Of course, cash Isa holders looking to invest in an AIM Isa must make sure they are comfortable taking on the additional investment risks – as with any stocks and shares Isa, capital is at risk and investors may not get back the amount invested.

In addition, companies listed on AIM normally involve more risk than those listed on the main market of the London Stock Exchange. Their performance tends to be more volatile, which means their value can fall or rise by greater amounts on a day-to-day basis.