In the tax year to April 2016, the government’s inheritance tax take was £4.66bn. That’s more than 20% on the year before – real money. I am not particularly against inheritance tax (I see it as a tax on free money for the living rather than a wealth tax on the savings of the dead). But as I know most of our readers are, I’m going to give you a quick run through the (legal) ways to make sure your estate doesn’t pay too much in years to come.
By 2021, inheritance tax is forecast to be bringing in £5.7bn. The best way to avoid inheritance tax is to die with too few assets to be obliged to pay it. This shouldn’t be too hard for a couple. You get £650,000 in allowance between you, plus (from 2020-21) another £350,000 exemption for your family home. So a total of £1m.
If you are well off, in your 60s or 70s and living in a house in the south east of England, £1m might not sound like much. But remember that your lovely defined-benefit pension dies with you; your defined contribution pension falls outside the inheritance tax rules (I’ll come to this later); and living till 90 doesn’t come cheap (a nice care home will easily cost £60,000 a year). You may have less to worry about than you think.
Those that are still concerned should note that the best way for the well-off to avoid paying inheritance tax is to have a lot of money in the first place: if you can afford to give large sums (or any sums) away without worrying about going short yourself, then doing so solves the problem. Assuming you live for seven years after handing over the cash, all is well.
You can also give some money away every year without worrying about the seven-year rule – £3,000 a year per person with carry-over for any allowance not used for a year. So a couple can give away £12,000 every two years, drop dead as they sign the last cheque and still leave their heirs with no bill to worry about.
Then there is the loveliest loophole of all – giving from income. You can give away as much as you like from your income every year as long it doesn’t affect your lifestyle. So you could just give away ordinary excess income – or you could find ways to convert your capital into income and hand it over that way (something that also removes the risk of having to pay capital gains tax when you transfer capital assets).
Next up is pensions. If you have a defined contribution pension (a pot from which you are producing your own retirement income), you can avoid paying inheritance tax by running down the assets you have outside that pension as much as possible, and those within it as little as possible. The idea is to die with little outside it and lots still in it. That’s because DC pensions pass to heirs inheritance-tax free (they’ll pay only their marginal rate of income tax when they withdraw it). It makes sense to spend the assets not liable for inheritance tax and keep the ones that are.
You can do the opposite with defined-benefit pensions (the ones where you get a percentage of your previous salary for life) by giving away the income from them under the “gifts from income” exemption and living on any non-pension income you have. Or you could of course do what more and more people are asking their advisers to help them do – transfer their DB pension into a DC scheme in order to be able to pass their asset value on inheritance tax free (a Prudential survey has half of financial advisers reporting a rise in inquiries about this). I’m not recommending this – the inheritance rules on pensions could easily change. But if I had a defined-benefit pension, I might ask about it too!
But what can you do if you are determined not to pay inheritance tax but your defined contribution pension is full and you don’t want to give up control of your assets? There is an easy (if not risk-free) answer here, too: you buy small companies listed on the UK’s Alternative Investment Market (Aim). Hold these for two years and most of them will qualify for “business property relief” – and so pass on inheritance tax free. Better still, they can be held inside Isas, so the income from them can come tax-free while you are still alive too.
There’s more. Brexit has given you a neat little opportunity to buy them. In June 2016 UK small companies saw their worst ever month of underperformance relative to large companies (thanks largely to the fact that smaller caps tend to be more domestically orientated). By the end of the month they were trading well below their historical average price/earnings ratio (12.4 times vs 13.5 times) and at the largest discount to large-cap stocks since 2001.
These are the kind of numbers, says Ed Heaven of fund manager Montanaro, which suggest that anyone prepared to invest now for the long term could end up “well rewarded”. You clearly can’t buy into the Aim index if inheritance tax is on your mind (not all of its listed stocks qualify) and nor would you want to (lots of Aim-listed stocks are rubbish and the index itself has performed horribly). So you will either want to be an excellent stock picker or to find a fund run by someone who is an excellent stock picker.
Ben Yearsley of Wealth Club points to the portfolios run by the likes of Downing, Unicorn and Octopus. But most of the wealth managers run them as well (Charles Stanley and Investec for starters) and my eye has been caught by the Aim Listed Portfolio Service (Alps) run by Adam & Company.
The vast majority of the stocks in its portfolio pay a dividend (some well over 4%); others have the kind of overseas exposure you’d expect from larger firms; and some are exposed to technology. It’s well diversified and reasonably low risk (to the extent that this is possible in the world of small-caps). It’s also returned 270% since its inception in 2011 (more than any of the rivals I have looked at) and has already made up a good amount of this year’s post-referendum losses (Alps is now down only 3% year to date at the time of writing).
However, you’ll need to have a reasonable amount of money to access these products. Most wealth managers have minimums for these services of £100,000 to £150,000; charge hefty fees for them; and prefer to offer them to clients that have significantly more money invested with them overall. But assuming you do have that kind of money (which is why you are reading this) they aren’t a bad place to shelter it.
So there you have it. inheritance tax: given the ease of avoiding most of it, anyone would think the government didn’t like collecting it any more than you think you’d like to pay it.
If you want to find out more about how to protect your family from inheritance tax – the “most hated tax in Britain” – and rescue up to £2m from the taxman, click here.
• This article first appeared in the Financial Times