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Inheritance Tax and the EIS: what you need to know as an investor
Somewhat understandably, Inheritance Tax (IHT) is something many families don’t like to talk about, and planning for it seems the last thing people want to do.
The reason behind this is similar to the reason why many don't like talking about life insurance - it's something that is only really of importance on the death of an individual.
But as with life insurance, the sooner you start thinking about Inheritance Tax, the better it is.
What is Inheritance Tax?
Before we move on, let's just clarify the details of IHT.
IHT is paid on a person's estate after they die. An estate consists of their overall wealth and possessions including their property, assets, vehicles, belongings and any other wealth they may have accumulated over the years. For the current tax year the IHT rate is 40%, paid on everything over £325,000 - the personal estate tax-free threshold.
As an example, if your estate is worth £500,000 you would pay £70,000 in IHT (£500k minus £325k is £175k, taxed @ 40%).
Planning for IHT
Most people are focused on giving their children and next generations the best helping hand they can; doing what's possible to set them up in life. Achievable when alive, as many of us have wealth in some capacity that's tied up in assets, it can become more so upon your passing.
Properties. Family heirlooms. Cash. They're just three examples of items often included in wills to be passed on to living relatives.
But as mentioned, the value of any estate can be taxed at 40%.
There are a number of caveats here - the tax free allowance can be up to £850,000, and IHT doesn't apply if you're leaving everything to your spouse or a charity - and many can believe it won't apply to them.
However, when you consider the average house price in the UK is in excess of £225,000, add into this cash, life insurance policies and any other assets (think cars, jewellery, etc) and you could easily exceed the £325,000 bracket.
It's for this reason why planning for IHT is so important - and investments that are IHT-exempt that can be passed to family can be a key part of this.
The Enterprise Investment Scheme (EIS) is one way in which an estate can be protected from IHT and grandparents or parents can share their wealth in a penalty free way with the loved ones they leave behind.
How can EIS assist with IHT?
The EIS was introduced to encourage private investors to invest directly in unlisted early-stage businesses, incentivising investors with a range of tax reliefs and benefits.
EIS investing can be ideal for investors in later life who have a large estate that requires IHT exemption relatively quickly. There are three key reasons for this:
- You can invest up to £2,000,000 per year in EIS (the new legislation doubled the limit for knowledge intensive companies)
- Your EIS investments achieve IHT exemption after only two years, much shorter than the seven years required by some other asset classes
- You retain control of your investments throughout your remaining life as opposed to having to place them under the immediate control of your beneficiaries
In addition to these IHT incentives, as mentioned in our previous blog posts, there are several other tax benefits an investor can take advantage of when investing in an EIS eligible company.
For instance, the investor could also benefit from:
- Income Tax Relief of up to 30%
- Loss relief should the investment be sold for less
- Capital Gains Tax reliefs, deferrals and exemptions
To reduce your IHT liability with EIS investments, you may need to introduce an element of managed risk to your portfolio through investments in companies that are EIS eligible, and consequently earlier stage than other investment opportunities in the market.
Moreover, the incentive of achieving exemption from IHT at 40% may well be sufficient to make risk, growth or income of little concern. Ultimately, the prospect of increasing your exposure to risk should be considered in the context of the certainty of IHT liability at a rate of 40% on an estate above your nil-rate band.
Investing into EIS-eligible opportunities
Making an investment into EIS-eligible opportunities should be done first and foremost to support the growth of the business. Any tax reliefs should always be a secondary focus - but this doesn't take away from the fact they are extremely generous.
With investments able to be made relatively easily - and from as little as £100 - the reliefs and incentives can not only help mitigate the level of risk involved, but they can support your financial planning when it comes to your future Inheritance Tax liabilities.