Octopus Investments, a smaller-companies fund manager, will launch a scheme tomorrow that exploits the inheritance-tax (IHT) exemption given to shares listed on AIM without the danger of losing money.
London's junior market has become one of the easiest ways to move your assets out of your estate for IHT purposes because the chancellor has closed off many other avenues.
The tax is levied at 40% on the value of estates worth more than £285,000, but most shares listed on AIM become free from death duties once you have owned them for two years.
Despite their obvious tax benefits, many families have been too nervous to put money into the market because of the high risks. Between January 2000 and April 2003, for example, AIM plunged 82% compared with a fall of 53% in the FTSE 100, leaving investors with heavy losses that eclipsed all the tax benefits.
But Octopus’s plan promises you will never lose money. While many stockbrokers, including Collins Stewart, Brewin Dolphin, Christows and Smith & Williamson, offer rival AIM services, this is the first scheme to give 100% capital protection.
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Simon Rogerson, chief executive of Octopus Investments, said: “As well as falling outside the estate for inheritance tax after only two years, investors can relax in the knowledge that their investment is protected no matter what happens.”
The protection is provided by a group life-assurance policy backed by General Re. This guarantees that, at death, if your investment is worth less than the original amount you put in, the shortfall will be paid to your estate.
Say you put £100,000 into the scheme. You die after three years, during which time the AIM market has plunged, so the shares in your plan are worth only £80,000. They would go to your beneficiaries and, because AIM shares held for two years or more qualify for “business property” relief, the payment would be exempt from IHT. It is still £20,000 short of your original investment, however. Under the Octopus plan, this shortfall would be paid to your estate out of the life policy. This payment would also be tax-free because it has been written in trust, meaning that your family inherits the full £100,000 of your original investment.
There is a price to pay for this protection in the form of diluted returns. In a good market, gains from the plan will be lower than if you had opted for a scheme without protection because you forgo any dividend income. Octopus estimates this is worth about 1.5% a year in gains.
So if your portfolio returns 10%, including dividends, you would receive about 8.5%. On a £100,000 portfolio that is the difference between a gain of £10,000 and one of £8,500.
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But Paul Ilott of Bates Investment Services, a financial adviser, believes many people will be willing to pay this price for the extra piece of mind.
He said: “Many people are not giving due consideration to AIM inheritance-tax portfolios at present because they look at them only from a high-risk-investment perspective. The prospect of capital protection is very attractive.”
There are limits on the amount of money you can shelter in the scheme. The minimum investment is £30,000 and the maximum £250,000. Most unprotected schemes do not impose such low maximums.
Charges are also at the high end of the scale. There is a 5% initial charge and a 2% annual fee. An unprotected plan from Collins Stewart, by comparison, has a 3% entry fee and 1.5% annual charge. At Christows you would pay 4% initially and 1.1% annually.
Doing it yourself is cheaper. If you choose your own shares you cut out all the charges, except dealing fees — and you could take out a life-insurance policy to protect your estate from market falls.
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A whole-of-life policy guarantees to pay a certain amount, called the sum assured, on the death of the policyholder with no specified term. However, this is a very imprecise form of protection and whole-of-life plans can be expensive. If a 75-year-old man had a £100,000 portfolio, he might decide that the market was unlikely to fall more than 50% and therefore take out a policy for £50,000. The monthly premiums would be £259, according to Torquil Clark Life Insurance.
But managing your own portfolio is not for the fainthearted. AIM stocks are not well covered by market analysts, making it difficult to do your own research. About 1,500 firms now have quotes on the junior market, compared with only 10 when it was launched a decade ago — and not all AIM-listed firms get the IHT exemption.
Shares in businesses that engage in “substantial” non- trading activities, such as property and finance, are not generally eligible for the IHT relief, for example.
Pick the wrong shares and your family could face an unexpected tax bill when you die.
The stocks that Octopus is considering for its clients all qualify for the IHT tax break, the firm says. These include Majestic Wine, the off-licence chain, and Parkdean Holidays, a holiday-park operator.
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When AIM shares are sold, any profits are liable for capital- gains tax, although they qualify for higher rates of relief than most other stocks. The top rate of tax of 40% — applicable if you have held the shares for less than 12 months — falls to 10% after two years.