How to Use Investment Strategies to Reduce Inheritance Tax Liability

Inheritance tax (IHT) is a growing concern for many individuals, especially as rates and thresholds remain frozen. The UK Treasury is expected to collect £42.1 billion in IHT from 2023 to 2028, prompting many people to explore investment strategies that can help reduce their potential tax burden.

If inheritance tax is a concern for you, there are a number of ways to potentially mitigate or even avoid its impact on your estate. From setting up trusts and utilizing gifting allowances to exploring tax-efficient investment options, there are several strategies to consider.

Here’s a look at some of the investment opportunities designed to reduce inheritance tax exposure:

Tax-Efficient Investment Options for Inheritance Tax

Several tax-efficient investment routes can help you reduce your IHT liability, including:

• Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)
• Inheritance Tax (IHT) portfolios
• AIM ISAs

However, it’s important to note that these investment vehicles often come with higher risks, which makes them more suitable for high-net-worth individuals (HNWIs) or sophisticated investors with an appetite for risk.

These strategies generally qualify for Business Property Relief (BPR), which allows certain business assets and shares to be passed on free from IHT when the investor dies. Let’s dive deeper into these options.

Understanding Business Property Relief (BPR)

BPR is a significant benefit for investors looking to reduce their inheritance tax exposure. It allows certain shares in qualifying businesses to pass on to beneficiaries without incurring IHT, provided the shares have been held for at least two years. Introduced in 1976, BPR was initially designed to help family-owned businesses avoid being sold to pay IHT upon the death of a business owner. Over time, governments have expanded the scope to allow investors in qualifying companies to benefit from IHT relief.

BPR-eligible companies can be accessed through direct investments or managed portfolios. While these options can offer the potential for significant IHT relief, they also come with a set of risks. It’s essential to remember that tax laws may change, and if the companies in which you invest lose their BPR-eligible status, you could lose the tax relief as well.

Using the Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS)

The EIS and SEIS are government-backed initiatives designed to encourage investment in UK startups and early-stage companies. Both schemes offer substantial tax reliefs, including the potential for 100% inheritance tax relief on shares that are held for at least two years.

• The Enterprise Investment Scheme (EIS): Launched in 1994, the EIS aims to attract investment in startups and scale-ups. In return, investors receive up to 30% income tax relief, exemption from capital gains tax (CGT), and the possibility of 100% IHT relief. EIS investments have raised over £25 billion for more than 36,000 companies since its inception.
• The Seed Enterprise Investment Scheme (SEIS): The SEIS, introduced in 2012, offers even more generous tax breaks than the EIS, including up to 50% income tax relief. Like the EIS, investments in SEIS-qualified startups may qualify for 100% IHT relief after two years.

While both EIS and SEIS offer promising benefits, they also come with risks. These schemes target high-risk early-stage businesses, and liquidity can be limited. Nevertheless, the tax reliefs offered can help offset the risk.

Investing in IHT Portfolios

An IHT portfolio is a professionally managed collection of private or AIM-listed companies that qualify for BPR. These portfolios are designed to reduce IHT liability while providing exposure to high-growth businesses. A typical IHT portfolio may contain 25-30 holdings in AIM-listed companies, or fewer if it focuses on private businesses.

These portfolios are suited for experienced investors with larger estates. They typically involve higher investment minimums, ranging from £50,000, and often come with initial charges, management fees, and performance fees.

The primary advantage of IHT portfolios is the control they provide over your assets. However, it’s important to understand that liquidity can be a concern, as shares in unlisted companies tend to be harder to sell than those on major exchanges. Additionally, IHT relief depends on the portfolio maintaining its BPR status. If the qualifying companies lose this status, the IHT relief could be lost.

AIM ISAs: Combining IHT Relief with Tax Benefits

An Alternative Investment Market (AIM) ISA is another option for reducing inheritance tax. AIM, a sub-market of the London Stock Exchange, lists smaller and younger companies. AIM-listed shares can qualify for Business Property Relief, which makes them eligible for IHT exemption after two years of holding.

AIM ISAs combine this benefit with the typical advantages of ISAs, such as income tax exemption, capital gains tax relief, and dividend tax relief. However, while AIM ISAs offer the potential for IHT relief, they come with risks, including volatility and limited diversification.

Is This the Right Strategy for You?

If you have a substantial estate that may exceed the IHT threshold, exploring tax-efficient investment strategies could help you pass more wealth to your heirs. Tools like IHT calculators can help you estimate your potential tax liability and assess your options.

If you’re hesitant about giving up control of your assets through gifting or trusts, BPR-qualifying investments may be a more flexible option, as they allow you to retain ownership during your lifetime while reducing your IHT liability.

Moreover, IHT-efficient investments offer faster relief compared to traditional estate planning tools. While gifts and trusts may take up to seven years to become fully IHT-exempt, BPR-eligible investments can provide 100% IHT relief after just two years, assuming the shares are still held at the time of your death.

However, it’s important to keep in mind that investing always carries risks, and there are no guarantees regarding the performance of these investments.

Conclusion

When looking to reduce your inheritance tax liability, a well-structured investment strategy can be an effective approach. Options like EIS, SEIS, IHT portfolios, and AIM ISAs offer the potential for significant tax relief while allowing you to maintain control over your assets. However, these investments come with risks, including volatility and liquidity concerns.

Before pursuing these strategies, it’s essential to consult with a financial advisor who can guide you based on your specific circumstances and risk tolerance. By combining these investments with other estate planning tools, you can minimize your IHT liability and pass on more of your wealth to future generations.