The thousands of investors who have had their million-pound portfolios frozen by AIG Life, a UK arm of the troubled American insurance giant, say publicly that they invested because its bonds were promoted as an alternative to deposit accounts.

Indeed they were, and these investors are right to be angry that what they saw as a souped-up “instant access” account is now frozen with the potential for losses of up to 12% — not what you would expect from cash.

Privately, however, some investors admit there was another reason: tax. Like most bonds offered by insurance companies, the AIG bonds came with a canny perk. You can withdraw up to 5% a year for 20 years from a bond with no immediate tax to pay. Tax at 20% has already been deducted at source, but higher-rate taxpayers can defer their additional 20% liability. And if you’re planning to retire to your bolthole in a lower-tax jurisdiction, you can avoid top-rate tax altogether.

I don’t expect your average family to feel much sympathy for wealthy people trying to avoid 20% tax on their income, but it does highlight the ludicrous nature of our tax system. Rightly or wrongly, people feel heavily taxed and will invest in complex structures they don’t necessarily understand just to avoid it.

I have more sympathy for those trying to mitigate inheritance tax (IHT). They’ve worked hard and paid tax on their income and most of their savings, so why shouldn’t they pass on those assets free from death duties? It’s just double taxation.

Again, though, thousands of people have been led into exotic and ultimately risky schemes simply for the IHT savings. Take Aim IHT portfolios. Most shares on the Alternative Investment Market (Aim), London’s junior market, are free from IHT once you own them for two years — the government’s bid to encourage investment in fledgling businesses.

The rule has also given stockbrokers a nice line in promoting portfolios of Aim shares for people who want to pass on their assets tax free.

That was all fine until the credit crunch hit. The FTSE Aim All-Share index is down a stomach-churning 62% over the past 12 months, compared with a 40% drop in the FTSE 100, wiping out any IHT benefit.

Stockbrokers argue they have protected investors from the worst of the falls — Williams de Broë’s typical portfolio was down 32.5% in the year to the end of September, against a 43% fall in the index. That said, this still wipes out most of the tax benefit.

There is a strong argument for a much simpler system, scrapping some of the more exotic reliefs in return for a much higher IHT exemption.

It is currently £312,000, and the government has gone some way to placating the middle classes by doubling it in last year’s pre-budget report. You can now pass your unused allowance to your spouse, taking it to £624,000 on the second death.

But with the average detached home in the southeast still worth about £400,000 according to Halifax, you only need about £200,000 in savings and investments before your heirs will have to pay tax at 40%.

The very rich can give away their assets to escape tax (as long as they live for a further seven years); the middle classes have to live off the money.

Alistair Darling will no doubt have other things on his mind in tomorrow’s pre-budget report but he shouldn’t forget the people who have paid off their mortgages, diligently saved their money and are loath to pay any more tax on it.

That’s why the Tory proposal to raise the allowance to £1m (or £2m for couples) won such plaudits. The middle classes would be taken out of the IHT net in one sweep. Anyone rich enough to be above that threshold can probably afford to give their money away anyway.

Kathryn Cooper is editor of the Money section

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