If you’ve paid into individual savings accounts (ISAs) during your life, you will be keen to know what happens to those accounts when you pass away. Here we take a closer look at the rules when it comes to transferring an ISA on death, and also explain if and when you might need to think about inheritance tax (IHT).
What happens to your ISA after you die?
Upon death, your ISA becomes a ‘continuing account of a deceased investor’ – also known as a ‘continuing ISA’. From this point on, no further contributions can be paid into the account. That said, if your ISA goes up in value while your estate goes through probate, this growth will be tax free.
This is in accordance with rules brought in in 2018. These state that your ISA can continue benefiting from ISA tax advantages – and continue to grow tax-free – for up to three years, while the estate is being administered. During this time, any interest, dividends or gains are exempt from tax.
(Prior to this, rules stated that the amount was fixed at the value on the date of death. As a result, any growth which happened while the probate process was taking place was taxable. The new rules were a welcome change to this).
ISA transfers on death
Once probate has been completed, the tax situation in relation to inheritance tax (IHT) depends on what happens to it. If your ISA is passed to a surviving spouse or civil partner, there is no IHT to pay. This is due to the ‘spouse exemption rule,’ which means an estate can be passed on to the husband, wife or civil partner, without the need to pay tax.
Further, your husband, wife or civil partner may also be entitled to an extra one-off ISA allowance.
Known as the ‘Additional Permitted Subscription,’ this means they effectively inherit your ISA savings – and get to maintain their tax-efficient ISA status. This extra allowance will be equivalent to either the value of cash or investments passed on at the time of your death, or the value when it is closed – whichever is higher. This tax break will not affect your partner’s own ISA allowance.
Note that this additional allowance is not permitted between any other individuals. Only married or civil partnerships can benefit. To claim an ‘Additional Permitted Subscription,’ the partner will need to fill out an application form. They have up to three years to claim this extra allowance.
What’s the deal on ISAs and inheritance tax?
If, on the other hand, ISA savings are being passed to anyone other than your spouse, they may be subject to IHT. So, if, say, your estate is worth more than £325,000, it’s probably the case that the recipient will have to pay IHT. The rate is currently 40%.
ISAs differ from pensions in this respect. Typically, pensions sit outside of an estate when it comes to IHT. This means that while, in most cases, pensions won’t count towards your IHT threshold when you die, ISAs will. This is an important consideration when weighing up pensions vs ISAs, as even though ISAs are tax-efficient in so many ways, they are not IHT-free, meaning 40% of your long-term savings could end up with the taxman.
Inheriting an ISA from a parent
It’s important to bear in mind that if you are passing on assets to children or grandchildren – known as direct descendants – and if your assets include your family home, you can pass on a further amount tax-free. This is the ‘main-residence nil-rate band’ and is worth £175,000.
Combined with the £325,000 IHT band, this additional £175,000 means that, in the current tax year (2023-24), the overall amount your loved ones can inherit tax-free is £500,000. (The aim of this nil-rate band is to allow people to pass on a family home more tax efficiently to direct descendants).
Seek advice
As the rules on IHT can be complicated, it may be worth seeking help from a professional. To find out more about speaking to an independent financial adviser, read more here.
Photo by Annie Spratt on Unsplash
