The four factors to consider when investing your ISA in Alternative Investment Market (AIM) shares to reduce inheritance tax

The four factors to consider when investing your ISA in Alternative Investment Market (AIM) shares to reduce inheritance tax

You have saved a significant investment in your ISA. The worry is that on your death it forms part of your estate for inheritance tax (IHT). Inheritance tax is only payable if your assets exceed the available nil rate band(s). Is it sensible to convert your ISA holdings to qualifying AIM shares to escape the IHT tax liability of 40%?

According to HMRC in 2017, six million ISA investors are over 65 years old, and for some IHT is a concern.

Several companies are promoting AIM ISAs as a means of IHT planning. There are specialist investment managers who create AIM portfolios designed for the IHT solution. All references to AIM shares in this blog refer to a professionally managed AIM IHT portfolio, not individual shares. Investing in individual AIM shares is unlikely to be appropriate for most retail investors.

This article does not represent personalised advice and readers should seek advice from a firm authorised by the Financial Conduct Authority (FCA) before taking any action.

This blog will help you to understand if this planning is right for you.

What is the attraction of holding AIM shares in an ISA?

An example will help. Consider a couple who are now in their 60s and have been saving money in ISAs (and PEPs before then). Gill’s ISA is worth £250,000 and George’s is £200,000. They have a mainstream stocks and shares ISA with a balanced portfolio.

Their entire estate including their Surrey home is worth about £3m.

On death the ISAs are included in the estate value for IHT, and £450,000 x 40% = £180,000 of tax. This leaves £270,000 of the ISA to be inherited by their children.

ISA AIM

George then reads an article which advises converting their balanced portfolio ISA into an AIM portfolio. The AIM portfolio is designed to qualify for 100% Business Relief. The Business Relief means that after holding the AIM portfolio for two years, the value is excluded from the IHT calculation (certain other rules apply). Please note the Financial Conduct Authority does not regulate Tax Advice or Estate Planning.

George and Gill take advice and convert all their ISA funds into an AIM portfolio. On death, after two years of 100% investment in AIM, the likely outcome changes:ISA AIM

On the face of it, the advice looks sensible. But like most things in life, it isn’t quite that simple. There are some major considerations before acting.

The four factors to consider

1. Investment risk

2. Investment charges

3. Alternative inheritance tax planning

4. The taxation implications

AIM explained

The London Stock Exchange operates the AIM sector (Alternative Investment Market). The September 2018 data shows a total of 937 companies of which 792 are UK based (85%). The market value of these companies is over £115 billion.

Of the total, 48 companies (5.1%) comprise half of the market value (49.2%). The other 889 companies have the other 50.8% between them. Market value is concentrated in fewer than 50 companies. AIM has a heavy UK bias.

Investors can name a lot of the companies in the FTSE 100 Index. They are household names. AIM is a different matter altogether. How many of the following names spring to mind?

The AIM Top-10 by market value

ASOS Plc Fevertree Drinks plc Burford Capital Ltd Hutchison China Meditech Ltd Abcam Plc
Boohoo Group Plc Blue Prism Group plc Dart Group Plc RWS Holdings Plc Secure Income REIT Plc

This group of 10 companies has a combined market value of £27.462 billion

The AIM Bottom-10 by market value

Vipera Plc People’s Operator Plc Flowgroup Plc Sabien Technology Plc Walcom Group Ltd
Inspirit Energy Holdings Plc MBL Group Plc Imaginatik Plc Marechale Capital Plc Slingsby Plc

This group of 10 companies has a combined market value of £4.73million.

Most companies on AIM are smaller companies. They have a shorter trading history than their cousins in the FTSE 100 Index.

1. Investment risk

The FTSE AIM All-Share Index tracks the performance of the entire AIM universe. The FTSE AIM 100 Index tracks the largest 100 AIM companies. Performance over the last 10 and 15 years is shown in the tables below. The FTSE All Share Index and UK consumer inflation index are also included for reference.

ISA AIM

 

ISA AIM

Source: FE Analytics. Past performance is not a reliable indicator of future results. The effect of fees, commissions and other charges are not included in the chart returns.

Investors in an AIM ISA must be prepared to ride the rollercoaster of returns. If the objective is to reduce the burden of IHT and pass wealth to your family, a market crash coinciding with death could have an effect on the outcome.

If your ISA is your primary investment, you need to take care. It may be a cash ISA, a stocks and shares ISA or even a blend. An AIM ISA is an investment in one small part of the global economy. Diversity will be modest. It’s a case of ‘don’t put all your eggs in one basket’.

If AIM was 100% risk with little or no reward, few people would invest. 2018 has seen some very good (short-term) performance (according to Intelligent Investor at www.ii.co.uk).

AIM’s best performers in 2018 so far shows the following:

There are 28 AIM-quoted shares whose share price has at least doubled over the course of 2018, the best of which has seen its share price balloon by seven times since the beginning of this year!

Four of the companies have floated in the past two years and most of the rest have been quoted for more than a decade. More than two-thirds of these companies have higher share prices than three years ago, although 11 out of the 21 companies have a lower share price over five years.

Some of the companies have been on AIM for a longer period and, over a decade, the majority of these companies’ share prices have fallen. The best performer over five years is video localisation, dubbing technology and services provider Zoo Digital, where the share price has risen by 146% this year, and by 23 times over five years.

If you can’t stomach the rollercoaster effect, the investment risk of AIM in your ISA may overwhelm you. AIM shares are very high-risk investments and you could lose all of your capital. There may be no market for the shares and it may be difficult to make a disposal. The tax treatment depends on your individual circumstances and may be subject to change in future.

2. Investment charges

It is easy to invest in global tracker/index funds with investment charges between 0.2% and 0.5% a year. How does this compare to AIM shares within your ISA?

Research in the AIM sector suggests you would pay an average 1.5% annual management charge and 0.5% in dealing fees. Initial and exit charges may be added on as well.

Based on an AIM investment of £100,000 you could expect to pay £2,000 or 2% on an annual basis for investment management. Add in another £1,000 on entry and exit.

A financial adviser charge may add 1% ongoing or £1,000 (costs will vary). As a grand total it may cost £3,000 annually, plus potential transactional costs, to make a £100,000 investment in AIM shares.

The potential returns may validate an investor’s decision to invest in AIM shares. Charges can be an important consideration. Anyone considering investing their ISA in AIM stock should seek independent financial advice from an FCA authorised firm.

3. Alternative inheritance tax planning

Your aim is to reduce your IHT bill. This means your family gets more of your money. There are alternatives to AIM ISAs.

Gifting ISA money allows you the benefit of seeing the effect of your gifts. We call this giving with a warm hand as opposed to giving with a cold hand. As a bonus, the gift will fall out of your estate after seven years.

Pensions provide a tax-efficient vehicle for inheritance tax reduction if:

  • you haven’t hit the lifetime allowance (£1,030,000)
  • you have unused annual allowance (up to £40,000 tax year 2018/19)
  • in some cases, unused annual allowance can be carried forward from the last three tax years

You will only receive tax relief on personal contributions made before age 75 and tax relief is limited to the level of your earnings in the tax year (or £3,600 if more).

Personal pensions and Self-Invested Personal Pensions (SIPPs) normally fall outside of your estate for IHT purposes. If you die before age 75 any beneficiary can access your money purchase pension pots tax-free.

Money from a tax-free ISA invested into an active pension can make sense.

You could give your ISA away to good causes or for the national benefit. However, if you need your ISA for income or dip into it for spending, this option isn’t helpful.

Read more about alternative ways to cut your inheritance tax here. 

4. The taxation implications

Your ISA is free from income tax on any income or dividends. It is free from Capital Gains Tax (CGT) on all gains made. These are valuable tax benefits and you can access your ISA money easily.

One drawback is that after saving into an ISA, on death it forms part of your estate. As such it may be liable for the 40% IHT charge. Converting your ISA to a qualifying AIM portfolio (exempt by way of Business Relief), can add freedom from Inheritance Tax (after two years).

Seasoned financial press readers will know about the Residence Nil Rate Band (RNRB). In full form, and in conjunction with the existing nil rate band of £325,000 per person, a couple could have £1m free from inheritance tax in 2020/2021 (rising with CPI each tax year thereafter).

For large estates valued at over £2m, entitlement to the RNRB (and any transferable RNRB) is tapered away by £1 for every £2 over £2m. The valuation is on an individual’s estate immediately before death and includes all assets (after liabilities). The valuation is before any exemptions or reliefs. This means that a BR qualifying AIM portfolio will form part of the estate to determine whether the RNRB is tapered.

AIM investments must be owned at death to benefit from BR and reduce your inheritance tax. Readers should take advice from a financial adviser and/or a solicitor.

Investors who had the appetite for a riskier investment when investing in an ISA AIM portfolio may lose it as they approach old age. To qualify for the IHT exemption, the qualifying ISA AIM portfolio needs to be held on death. In effect, a one-way bet.

You should ensure you have a holistic view of your finances and relevant legislation before purchasing AIM shares in your ISA.

At Capital we believe in doing the right thing for the right reasons.

If you would like advice from a chartered financial planner on if an ISA AIM is right for your situation, please click here to contact Capital. 

 

 

 

 

 

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