Navigating your way through BPR, EIS and Aim investments

There is no doubt that talking about Inheritance Tax (IHT) invariably invokes an emotional response. It is a tax on the transfer of wealth to future generations, which is invasive and comes at the worst time in a person’s life. 

For all of the air time and press coverage IHT receives, it actually contributes very little to government coffers. It is estimated 5 per cent of deaths in the tax year just ended will give rise to an IHT liability – roughly 30,000 estates. The government receives about £5bn from IHT revenues each year, less than 1 per cent of total revenue, although this is expected to increase by £1.5bn in the next five years with rising prices for property and equity. 

This has led to calls for IHT to be scrapped completely and replaced with various alternatives, including immediate taxes on recipients of lifetime gifts and increased taxation for pensioners. 

Most recently, Chancellor Philip Hammond announced plans to raise probate fees by introducing a tiered system that, at the top end, will result in a fee of £20,000 for those with estates worth more than £2m.

The argument over whether the wealthiest in society should pay more is not really the point. One of the issues is that a client could have a relatively simple estate containing a main residence valued at £2m and little else in the way of liquid assets, but their executors might still be forced to pay £20,000. However, the executors of a smaller estate valued at less than £1m, which could be much more complicated to administer, will pay a fraction of this amount – £4,000.

So, the case for well-considered and effective IHT planning is as topical as ever.

Advisers are faced with a plethora of options, from simple life assurance to purchasing swathes of woodland, but the starting point has to be an accurate assessment of the client’s likely IHT liability. 

Without a crystal ball, an IHT calculation can usually only be a snapshot in time. However, advisers are increasingly using cash flow planning software not only to project the future value of assets, but also to consider the affordability of lifetime gifts to individuals or charities and the capacity for IHT-efficient investment. 

In my experience, using this balance-sheet approach with clients encourages constructive conversation about a topic few want to dwell on. 

A range of commonly understood and used insurance-based products to help with IHT planning already exist. Arguably, the simplest is life assurance. The most straightforward is whole-of-life cover, ordinarily on a joint-life, second-death basis. Premiums, usually qualifying as normal expenditure out of income, are effectively an advance to the nominated beneficiaries. The compound returns on those premiums are often attractive and relatively risk free.

Discounted gift trusts and gift-and-loan trusts are tried, tested and effective planning tools. At the other end of the spectrum are more esoteric schemes, such as investing directly in forestry and woodland which, in addition to IHT relief, can also confer income tax and capital gains tax benefits. Not surprisingly these are relatively long-term investments and tend to be suitable for those with sufficient investment experience and investable assets.  

For clients who have decided not to make outright gifts during their lifetime and/or where life assurance is not appropriate, investing tax efficiently allows them to keep control of their money while achieving an IHT saving over time. Typically this is achieved by investing in assets that qualify for business property relief (BPR), which reduces the value of the asset when calculating how much IHT has to be paid. 

Investing in a portfolio of Alternative Investment Market (Aim) shares is a good example. Certain Aim shares qualify for BPR and once the client has held these shares for two years they qualify for 100 per cent BPR, meaning a zero value for IHT purposes. The client still owns the Aim shares and, unlike an outright gift, can access the capital if the unexpected happens. 

However, Aim shares are higher risk, volatile securities. In the worst-case scenario, a client could lose 100 per cent of an Aim investment. Care must be taken to ensure clients have the risk tolerance and capacity for loss to make this kind of investment. A balanced investor, however you define this, should remain a balanced investor, even after an investment into Aim.

On death, Aim investment also offers spouses and civil partners the opportunity for a second bite at the cherry. For example, a husband leaves his Aim shares (that he has held for two years) into a discretionary trust on death; the shares pass into the trust without an IHT charge. His widow buys the shares from the trust with cash, thus gaining an asset that immediately has a zero value for IHT purposes, assuming she still holds it at her death, and removes the equivalent amount of cash from her estate, which would otherwise be subject to IHT. 

Many of the concerns about Aim are similar with Enterprise Investment Schemes (EIS). These schemes offer a broad range of tax incentives and are perhaps better known for the opportunity to defer capital gains tax or mitigate income tax. From an IHT perspective, EIS shares ordinarily qualify for BPR after two years, giving a zero value if still held on death.

EIS shares are high-risk investments – although there are varying degrees of risk across individual schemes – and are unlikely to be suitable for cautious clients without a broad asset base. The liquidity, or illiquidity, of an EIS should always be kept in mind. Beneficiaries wanting to access their inheritance may be frustrated by the inability to sell EIS shares quickly or without applying a discount. (This is unhelpful to an adviser hoping to build a relationship with the next generation). To my mind, if the driving objective is mitigating IHT, there are likely to be more suitable options.

For clients trying to mitigate IHT, but not willing or able to take higher levels of investment risk, there are alternatives. Many specialist companies design structured investments that offer clients BPR relief, but with lower volatility and returns uncorrelated to equities. They do this by investing in asset-backed trades such as renewable energy farms, forestry and commercial lending. The aim of these schemes is to mitigate a 40 per cent IHT liability, not yield high investment returns. Typically clients might expect a return of three per cent a year. 

The biggest disadvantage with using BPR for IHT planning is what happens if your client dies before two years have passed. Life assurance is one option, but what if your client is in ill health or advancing years, making the cost prohibitive? 

One innovative product in the marketplace now offers clients the opportunity to insure the risk in the first two years by using a group life assurance policy. Another will rebate any accumulated annual charges and waive the exit dealing fee on death within the first two years and rebate the initial fee if death occurs in the first three months. Yet another helps estate administration by participating in the direct payment scheme, allowing executors to instruct payment to HMRC directly from the investment to speed up probate. We can certainly expect further differentiation and development in this area. 

It is important to note that all of the products highlighted come with charges, some of which are significant. Advisers need to ensure clients understand the cost to enable assessment of the most suitable option. 

There is a broad range of IHT solutions and often the client’s objective will be met by a combination of those solutions. IHT, in whatever form it takes, will continue to be an emotive issue. Talking about the range of products available and tailoring a solution to meet the client’s objective is more important than ever before.

Rebecca Williams is a chartered financial planner and client director of Brown Shipley

Key points

Discounted gift trusts and gift-and-loan trusts are tried, tested and effective IHT planning tools.

On death, Aim investment also offers spouses and civil partners the opportunity for a second bite at the cherry.

EIS are high-risk investments, although there are varying degrees of risk.