This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Mark Williams, business line manager for inheritance tax products at Octopus Investments, looks at how AIM shares are adding a new dimension to ISAs.
ISA seasons come and go and, apart from the increases in the investment allowance, each one is usually much like the one that went before – until 2014. This year, for the first time, investors can choose to hold shares from the Alternative Investment Market (AIM) in their ISA and, as a result, get exemption from inheritance tax.
It’s hard to overstate the potential impact of this change, which came into effect in August 2013, on thousands of people who’ve built up sizeable ISA portfolios over the years. Until now they’ve benefited from tax-free growth and income on their ISAs, but they’ve faced the prospect that when they die, the investments will form part of their estate.
This has meant that if the value of the investor’s estate is more than £325,000, their family could well have to pay 40% of the ISA investments’ value in tax. Traditional estate-planning tools, such as gifts and trusts, are not a suitable option for many people because they involve giving the assets away – whereas ISAs stay in the investor’s name
There are currently 1.7 million over-65s with ISAs worth £30,000 or more, so this is likely to be a significant concern for thousands of investors. In the past we have heard accounts from some of the advisers we work with of investors having felt they needed to take investments out of the ISA wrapper so they could include them in their estate planning. But giving up the ISA tax advantages that have built up over many years isn’t something these investors have been happy about.
How AIM Shares can Help
An ISA investing in AIM shares can offer a solution to this problem as a result business property relief from HM Revenue & Customs (HMRC). This relief is available on shares in trading businesses, including many of the companies listed on AIM. As long as the owner of the shares has had them for two years, and still owns them at the time of their death, HMRC will not charge inheritance tax on them.
The challenge is that HMRC never says in advance whether a stock will attract business property relief or not, and whether or not a company meets the conditions of the relief can change over time. So ISA investors should rely on a specialist to choose their AIM shares for them – someone who has the experience and expertise necessary to know which ones will qualify.
So the opportunity to hold AIM shares in an ISA now means that investors can have their cake and eat it, with all the usual income tax and capital gains tax benefits of the ISA being preserved with exemption from inheritance tax added on top.
The Outlook for AIM
Of course, no investor should decide what to do with their money solely on the basis of the possible tax advantages. They need to be confident that it is the right investment for them. In the case of an AIM investment, this means accepting that they face a higher level of risk with smaller companies than they would with blue chips.
My colleague Richard Power, who heads the Smaller Companies team at Octopus, believes there are reasons to be optimistic about the outlook for AIM companies.
Power says: “It is easy to forget that smaller companies have been outperforming the FTSE All-Share for a number of years. Following the financial crisis, the FTSE SmallCap Index outperformed the FTSE All-Share in 2009, 2010, 2012 and 2013. The one period of underperformance was in 2011 when investors’ risk appetite was rocked by the prospect of a double-dip recession.
“AIM is also enjoying something of a revival at the moment with fundraising activity at higher levels than it has been for many years. The market is home to many well-established, high quality growth companies and we continue to see exciting opportunities for investors. Combined with the improving outlook for the UK economy, the increased investor interest in smaller companies looks set to make 2014 a great year for AIM.
“There will always be shorter-term volatility, but investors should consider AIM investments as long-term holdings in order to benefit from the attractive growth potential that the market offers, as well as the valuable tax reliefs now available if shares are held within an ISA.”
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