Inheritance tax (IHT) is often described as an avoidable tax, because careful planning can allow you to pass everything on to your loved ones instead of the taxman. There are a variety of tax-efficient investment options that can form part of a plan.
At the exotic end of the spectrum is forestry, which can be a particularly tax-efficient investment. There’s no income tax to pay on felled timber and no capital gains tax on any increase in the value of timber. Once you’ve owned a woodland for two years, it qualifies for 100 per cent business property relief, putting it outside your estate for IHT purposes.
But you don’t have to buy your own forest to take advantage of this tax break. Forestry and energy firm FIM offers an unregulated collective investment scheme for smaller investors. The scheme requires a minimum investment of around £30,000.
Anthony Crosbie Dawson, portfolio manager at FIM, says growth prospects can be good. ‘Physical growth of this asset, typically Sitka spruce, is about 6 per cent a year, and although timber prices have dropped recently, our timber trusts have returned anything from 4.7 to 15.4 per cent a year since 2000,’ he says. ‘There are risks though, and I wouldn’t recommend that it form more than 5 per cent of your portfolio.’
While investment levels mean forestry is really only suitable for high-net-worth individuals, there are other ways to take advantage of business property relief.
Aim shares will also move outside your estate after you’ve held them for two years, but shares have to be qualifying. Although HM Revenue & Customs (HMRC) doesn’t publish a definitive list, it does state that they must be trading rather than investment companies.
Some large companies are listed on Aim, but it’s not an investment for the risk averse. Arthur Childs, managing director at Arch Financial Planning, explains: ‘Aim shares can be high risk and illiquid, so I recommend the products offered by Octopus and Close. These are portfolios of qualifying Aim shares, giving you the benefits of diversification.’
You’ll still need to have a reasonable amount to invest. Octopus Aim Inheritance Tax Service, for example, has a minimum investment of £25,000, but you do retain control of your investment.
If you would like to invest in less risky assets and you’re happy to forfeit some control over your money, a trust may be worth considering. Although HMRC has put the squeeze on trusts over the past few years, it’s still possible to use one to shift money out of your estate for IHT purposes.
Mark Benson, technical manager at investment firm Way Group, says: ‘The rules have got tougher, but it can still be an effective way of estate planning. On top of this, you don’t have to invest in high-risk assets such as Aim shares or forestry: you can build a portfolio to suit your appetite for risk.’
While setting up a bespoke trust can be expensive, plenty of off-the-shelf products are available. Plans work in different ways, so it’s important to pick one that suits your requirements. With most trusts, although any growth will be immediately outside your estate, you’ll need to wait seven years for it all to be exempt from IHT.
The most popular scheme at Way Group is its lump-sum flexible plan. With this, you gift a portfolio to the trustee but carve out an interest – of 10 per cent of the portfolio a year, for example – to enable you to receive an income from the plan in the future. At every anniversary of the scheme the trustees will look to pay you your interest, but you don’t need to take the full amount. You could take less and defer anything you don’t need for another year. Although it takes seven years for the original portfolio to be outside your estate for IHT purposes, any growth is immediately outside it. ‘This works well where someone is happy to defer income in the early years, but wants to have the reassurance that it’s available if they need it as they get older,’ says Benson.
With any of these trust-based IHT schemes, you need to be careful how much money you put in. If you exceed the nil-rate band of £325,000, the taxman will demand an immediate 20 per cent tax charge on the excess. And you need to keep tabs on any other IHT planning you do involving a chargeable transfer into a trust, so that you don’t exceed the nil-rate band across the previous seven years.