Inheritance tax and the EIS: what you need to know as an investor

Inheritance Tax (IHT) can be a topic that many families, and indeed investors, can be reluctant to explore. Whilst completely understandable, avoiding planning for later life as an experienced investor can have significant consequences.

With inheritance tax (IHT) currently sitting at 40% in the UK, it's easy to see how without proper planning, a large proportion of an individual's estate can be taxed by the government upon passing.

Thankfully, a range of tools exist in the UK that can aid in minimising the amount of hard earned capital and assets that are taxed from an individual's inheritance - just one of which is the Enterprise Investment Scheme (EIS). 

Just one of the EIS's range of generous tax reliefs, inheritance tax relief increases the control venture capital investors have over their assets in the long term, and to fully understand how it works, a handful of aspects should be considered first. 

What is Inheritance Tax?

IHT is paid on a person's estate after they die. An estate consists of an individual's overall wealth and possessions including their property, assets, vehicles, belongings and any other wealth they may have accumulated over the years.

The current inheritance tax nil-rate band is £325,000 in the UK, but after British government announced the introduction of an additional 'main residence transferrable allowance' of  £175,000 in 2021, now the IHT-free threshold can be up to £500,000 provided at least £175,000 of that comes in the value of a first home. Any inheritance over this value is taxed at 40%.

For example, should a high-net-worth individual pass down an inheritance worth £750,000, £100,000 of this would be liable to be taxed in IHT (40% of the surplus £250,000). 

Planning for IHT

A key priority for many individuals when planning for later life, deciding how to best give following generations a helping hand when they're gone is a contested subject, but generally, assets and capital will play a role in this process.

Properties, family heirlooms and cash are just three examples of items often included in wills to be passed on to living relatives, but as mentioned, these are all liable to be taxed 40% should they surpass the nil-rate band.

But before any UK citizen looks to put an inheritance tax plan in place to help shield their most valued belongings, it can be helpful to first consider a number of caveats - with the UK IHT-free allowance being up to £500,000, and IHT not applying if you're leaving everything to your spouse or a charity, developing an IHT plan may not be essential for everyone. 

However, when you consider the average house price in the UK is in excess of £275,000, and add into this cash, life insurance policies and any other assets (from cars to art to properties), it's easy to see how this threshold could be exceeded, especially in the case of high net worth individuals. 

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 play a key role in reducing, or even avoiding inheritance tax deductions entirely.

The Enterprise Investment Scheme is one way in which an estate can be protected from IHT, and grandparents, parents and acquaintances can share their wealth in a penalty-free way with beneficiaries.

A great tool when planning IHT is an inheritance tax calculator. They can be used to provide a quick estimate of your potential IHT bill, helping you in your tax planning journey.

How can EIS assist with IHT?

The EIS was introduced in the UK in 1994 to encourage private investment into the UK's most innovative, early-stage companies with the help of a range of attractive tax incentives - one of which being full inheritance tax relief. 

EIS investing can be ideal for investors planning for later life who have a large estate that requires IHT exemption relatively quickly. There are three key reasons for this:

1. You can invest up to £1 million per year in EIS (rising to £2 million should all investment over the original limit be invested into knowledge-intensive companies [KICs])
2. Your EIS investments achieve IHT exemption after only two years, much shorter than the seven years required by gifts, trusts, and some other asset classes
3. 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 such IHT incentives, there are several other tax advantages an investor can benefit from when investing in an EIS-eligible company that can further the value of this tax-efficient route.

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 into 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 less concern, but it should always be remembered that investing in early-stage companies is a higher risk/higher return strategy, and so including EIS investments as part of a balanced portfolio can be crucial. 

Investing in EIS-eligible opportunities

Alongside the transformative tax advantages the EIS can offer experienced investors keen to reduce tax bills, minimise risk and plan for later life, the long-term positive impact that investment into some of the UK's most innovative startups and scale-ups that such schemes can bring can be of equal appeal.

Where accessing tax-efficient, growth-focused impact-driven investment opportunities could once be a laborious process, the growth of schemes like the EIS the increased accessibility of EIS investment opportunities through channels like co-investment platforms have made "doing well by doing good' more achievable now than ever before.