IHT: Not just a tax on the wealthy

Property values may have increased by 106% in the past decade but inheritance tax thresholds have not. Jonathan Gain of Stellar Asset Management looks at why IHT planning should be a high priority for clients of all ages

Over the past 10 years, the number of estates liable to pay inheritance tax at 40% has increased from 19,500 to almost 50,000. This has arisen because individual’s principal asset, their family home, has increased at a greater rate than the threshold at which the taxation liability kicks in.

In 2000, the average family home in the UK was valued at £81,000 and the inheritance tax threshold was £231,000. Today, those numbers are £167,000 and £325,000, an increase of 106% and 45% respectively.

Crossing the threshold

A survey we conducted in February this year highlighted IHT was a primary concern for both advisers and their clients, and when you consider how many people are now captured within the threshold it is perhaps not surprising inheritance tax planning has taken a more prominent stage for financial advisers and their clients.

The Labour government made clear its intentions to freeze the IHT threshold for the next four years at £325,000. The Liberal Democrats were largely silent on their intentions toward IHT policy, and the Conservatives pledged to increase the threshold to £1m (although this would likely take some considerable time to implement, given the drastic state of the public finances.)
Accordingly, an increasing number of estates will need to consider IHT planning.However, it is worth noting the number of cases paying some form of death duty today is at its lowest level since 1939 when records were first available; back then, some 30% of the population were caught.

Unfortunately, despite this, most people have gone through their lives without any consideration for IHT planning, principally because of the belief that it affected only the rich. This is no longer the case and many issues being faced today by families are a direct result of being dragged into the tax net by stealth means. In our experience, this has meant many elderly investors should take immediate action if they wish to prevent their families from facing increasing tax liabilities.

Advisers can assist clients and their families in this. Financial planning will often focus the clients’ families’ minds on their financial situation and how they might deal with any benefits, or indeed start planning for their own estates with guidance from advisers. Consequently, as we move through the generations, awareness and planning for IHT comes more to the fore.

Alternative relief

As time passes for older clients, the more traditional routes of planning, such as gifts and any form of trust, which require the donor to live for a further seven years to be valid, become less certain solutions. A further concern is that this type of planning removes control of the capital from the donor.

However, there are alternatives; one of these is to make use of opportunities which qualify for Business Property Relief (BPR). An investment in BPR qualifying trades results in the liability to IHT being completely mitigated after only two years of ownership and all investments can be made in the client’s name, providing them with complete control as to how matters may be dealt with on their passing.

There is a wide range of activities that qualify for BPR and, as its name suggests, relief from IHT can be applied to any trading business with the notable exception of financial services companies.

Mitigating matters

In the aforementioned survey we conducted in February, we found 80% of advisers are now more likely to look at IHT mitigation opportunities than in the past and that wealth preservation is now the most common concern they have for the clients.

So, as with any business investment, clients would like IHT products to offer both the tax shelter and growth. At present, market focus is on mitigating tax, with some products that protect capital value using insurance: for example, offering clients’ piece of mind that capital value will not be eroded. However, what advisers should be seeking for clients is the ability for growth as well as shelter. Sadly, such funds are rare beasts.

Trust planning can achieve this, but it does mean the individual loses control of their affairs. An investment through a BPR qualifying scheme, where control remains and qualification for IHT relief applies after two years is therefore an attractive alternative. The most common examples of BPR qualifying schemes available at the moment are AIM stocks, property development and commercial forestry.

AIM’s roller coaster returns

As AIM is the most common of these I will focus on this for a moment. As a junior stock market in the UK, designed specifically for small and growing companies, it is a volatile market, one that can offer a roller coaster ride of returns. As such, a good fund manager is essential for anyone who is seeking growth and tax mitigation.

Unfortunately, as a recent review by Martin Churchill’s recent Tax Efficient Review highlighted, not all AIM fund managers who offer IHT mitigation services are delivering much more than tax mitigation. In the review, the top provider was Hargreave Hale, based on returns to investors, experience of the team, attitude to risk and fees. The AIM market lost more than 35% of its value over the past four years. If an investment had been made in Hargreave Hale’s IHT portfolio it would have actually increased in value by 6% over the same period.

In light of such uninspiring returns, Hargreave Hale aside, it is not surprising advisers seeking the best possible products for their clients have tended to focus on understandably popular capital protection additions for IHT mitigation products.

However, we believe the demands on advisers will increase over the next few years, particularly if baby boomers take on their own estate planning alongside that of their parents. When planning further ahead, the requirement for growth and tax mitigation is stronger. As such, advisers should be demanding more from portfolio managers in terms of returns.