The fact that Isa investments are free of capital gains tax on income makes them a great way to build up a substantial share portfolio. However, when it comes to passing your accumulated fortune onto your children, or grandchildren, it's a very different matter. Investments in an Isa aren't typically exempt from inheritance tax (IHT). So unless you pass an Isa on to a spouse (spouses can inherit each other's wealth free of IHT, effectively postponing the IHT liability until both partners have died), then on your death, those who inherit the money could lose 40% of those funds, warns Alex Davies, CEO and founder of Wealth Club. The good news is that there is a way to eliminate (or at least reduce) this bill by investing in shares on London's "junior" stock exchange, Aim.
Aim was set up in 1995 to make it easier for smaller companies to raise capital by providing a market that had less stringent listing requirements than the main market of the London Stock Exchange (hence the term "junior" market). The big benefit of Aim shares when it comes to IHT is that many of them are eligible for business property relief (BPR), exempting them from IHT. While BPR was originally intended primarily to cover shares in unlisted companies, many Aim shares are included in the exemption even though they can be bought and sold like any other public company.
Until six years ago, these benefits were qualified by the fact that Aim shares were considered too risky to be allowed in Isas. This meant that investors had to choose between the upfront benefit of exemption from CGT of Isas and the IHT benefits of Aim (though you were always able to hold them in self-invested personal pensions). However, in 2013 the government changed the rules, making Aim shares eligible for inclusion in Isas, which means that you can now get both type of benefits. A year later, Aim shares were also exempted from stamp duty.
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Unfortunately, like everything else when it comes to tax, there are some important caveats to the exemption from IHT. Firstly, you have to hold the shares for at least two years to qualify for BPR. This is designed to encourage long-term ownership rather than short-term speculation. We wouldn't view this as a huge issue buying shares with a planned holding period of less than two years is a high-risk strategy at the best of times, and shares on Aim tend to be more thinly traded, and have bigger bid/ask spreads (ie, a bigger gap between the buying and selling price). This means that it's in your interest to adopt a longer-term "buy and hold" strategy, otherwise you will end up racking up large transaction costs.
Another problem is that as noted above while many Aim shares are covered by the exemption, not all of them are. And unfortunately, as Davies notes, "it's not always obvious" whether a firm is or isn't there is no definitive list you can refer to, and the status of firms can change if they move into a different industry or are taken over. One rule of thumb is that shares in firms involved in what the average person might consider a "proper" business are IHT-exempt but those whose business is investing in other companies (such as investment trusts), or buying and selling property, are not. Firms with a dual listing on a recognised foreign stock exchange aren't eligible either.
An added complication to investing in Aim stocks is that they tend to be much smaller than those listed on the main market. Indeed, as of December 2018, the average market capitalisation of companies listed on Aim was just under £100m. As a result, the individual shares tend to be more volatile than larger rivals. While this means there are increased opportunities for outsize returns, the overall effect is to make Aim much more of "a stock-pickers market" that rewards those who are "willing to spend a lot of time on it".
Help from the professionals
Many people enjoy the detailed research involved in the quest to find the next Asos (the online fashion retailer has delivered an incredible 16,110% return since it was listed on Aim in February 2001 some of its wares are pictured). Or upmarket tonic group Fever-Tree (1,947% since June 2014). But if you aren't keen, or are worried about "passing on a giant headache" for a spouse or a child who is inexperienced with investing, says Davies, you could consider using a professional adviser. While Aim-focused funds and investment trusts are not exempt from IHT, many wealth-management firms will manage a portfolio of Aim shares in an Isa for you.
Just be aware that these services aren't cheap. Typically you can expect to pay 1%-2% a year in fees, along with an initial fee to set it up. You'll also have a chunky minimum investment (although if you're wealthy enough to be worried about IHT, this shouldn't be a huge hurdle). One lower-cost provider recommended by Davies is Blackstone Sington, which has no initial fee and an annual management charge of 1.25%, though it does require a minimum transfer of £50,000.
Looking to the future
So, what about the future? One big worry is that a government could remove (or limit) the IHT exemption. Given that many investors invest in Aim primarily for tax reasons, this could have a big impact on the market. However, while the Association of Accounting Technicians did call it an "anomaly that should be ended" last year, this is unlikely due to Aim's role in helping small business. Indeed, Gervais Williams, managing director of Miton Group, reckons that in the future BPR might even be extended to funds and trusts that invest in Aim shares.
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Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.
He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.
As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.
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