‘I cut my inheritance tax bill by £40,000 by investing in small companies’

One of the most tax-efficient ways to save is in an Isa, and during an investor’s lifetime, its contents are tax-free. But as soon as the holder dies, the amount held in it could be subject to inheritance tax, charged at 40pc.

However, there is a way to pass an Isa on to future generations while protecting the entire pot from death duties.

Nearly a decade ago, former chancellor George Osborne changed the rules to allow investors to put Isa money into shares on the Alternative Investment Market, known as Aim, as a way of encouraging investment in Britain's small and medium-sized companies.

Many – but not all – of these shares qualify for Business Property Relief – which means they are completely free from IHT.

One particular advantage of Aim shares is they become IHT-exempt once the investor has held them for over two years, said Alex Davies, of investment service Wealth Club. For money that is simply given away, it takes seven years for it to be free of death duties.

“Holding Aim shares in an Isa means they are free of income and capital gains tax as well, making them one of the most tax efficient investments available,” he added.

‘Even if the portfolio doesn’t do well, I’ve saved 40pc’

Laurence Cohen, 75, works as a chartered accountant. Having advised clients for decades, he knew the importance of planning ahead to mitigate investment tax.

“I decided I would move the money into Aim Isas for the IHT saving,” he said. Mr Cohen has £100,000 invested, which means he should save £40,000 in IHT once the minimum holding period of two years is up.

“The way I think about it, it’s not a short-term thing, it’s a long-term thing,” he said. “Even if the portfolio isn’t doing well, I’ve made a 40pc saving.”

Higher volatility

There are risks to investing in this way: Aim stocks are more volatile than those in larger companies. Their performance this year encapsulates this: while shares on Aim are down by a third, by comparison, The FTSE 100 is down 4pc.

David Henry, of the wealth manager Quilter, said: “Smaller companies tend to be more economically sensitive, and the performance of the alternative investment market during the year to date can be put down to the worsening economic environment, to an extent.”

Of the largest 100 companies within the Aim index, some of the worst performers this year have been “former darlings” of the index, he said, such as Boohoo, which is down 83pc. The best performers, meanwhile, are currently concentrated within the energy and commodities sectors – such as Atlantic Lithium, PetroTal and i3 Energy.

Mr Henry added: “In many ways, this higher volatility is the quid pro quo of receiving any tax advantage from investing in these shares.”

The rules around these investments are complex, and also there is a risk that these stocks’ IHT-free status may be changed in the future.

Mr Davies said: “Aim shares can be bought directly through a stockbroker. But complexities around which shares qualify for IHT relief and which don’t, together with the difficulty of building and managing a well-diversified portfolio, means many investors choose to pay for a professionally managed Aim share portfolio instead.”

Mr Cohen’s investments in AIM constitute 5pc to 10pc of his overall portfolio, but he said he would not want to put a larger percentage in Aim.

“As much as I’d like to do more for my grandchildren, I think it's important to have sufficient funds in case I need to cover care costs for myself or my wife.”