In this brief blog we are going to talk about the ISA inheritance rules from HMRC and how  the ISA inheritance rules by HMRC can be of help to you.

How does inheritance tax work?

“Each person has an inheritance tax-free allowance – called the “nil-rate band” – which enables them to pass on up to £325,000 to their heirs tax-free. Anything above this amount is taxed at 40 per cent.

And if your estate (all of the assets that you own) includes your family home, and you’re passing that onto children, grandchildren or any other “direct descendants”, you can pass on another £150,000, taking the total amount your heirs could potentially inherit to £475,000 free of tax in the 2019-20 tax year.

This special property allowance – called the “residence nil-rate band” – will increase by £25,000 next year, allowing you to pass on £500,000 tax-free.

For married couples and civil partnerships, there are major inheritance tax benefits. Your spouse can inherit all of your assets, including your Isa savings, investments and property, completely free of inheritance tax.

They can also inherit any unused inheritance tax allowance you have left when you die. If you haven’t used any of it up, the amount that can be passed on tax-free when your spouse dies effectively doubles, meaning your family could inherit up to £950,000 tax-free in the 2019-20 tax year.”

ISA inheritance rules HMRC 

George Osborne announced that we will be able to pass our ISA tax free to our loved one when we passed on(our spouse). The ISA inheritance rules by HMRC allow the surviving spouse to have an increased ISA allowance for a given year which is exactly what their partner will have left behind in their ISA accounts at the time of their death or the amount that is in their ISA account at the time of its closure.

This will protect the ISA inheritance from capital gains tax or income tax. The ISA inheritance rules by HMRC do not protect any other family members outside of the spouse who inherit an ISA from a loved one and this means that capital gains tax will be due on any ISA passed from a deceased to any other than a spouse. If there is still capital gains tax allowance left then you can use this to avoid paying capital gains tax but if you have used up your capital gains tax allowance then you will need to pay Capital gains tax. 

Pensions, on the other hand, will allow you to pass your pension pot to more beneficiaries outside of your spouse.

If you want to leave more of your ISA to beneficiaries which are not your spouse then you can reduce your beneficiaries tax liability further by investing in shares listed on the Alternative Investment Market (Aim) to minimise your inheritance tax liability. “Shares that qualify for business property relief are free from IHT as long as they have been owned for at least two years at the time of death.”

According to HMRC the new ISA inheritance rules will now allow the ISA in a deceased partners account to retain a tax-free status for 3 years after their death. This means the new ISA inheritance rules by HMRC allow those who are grieving enough time to sort out the estates of their loved ones.

ISA inheritance rules are very important as most people who are aged over 85 years hold more than 5% of their wealth in ISA products in contrast to any other age group. This is according to the Institute for Fiscal Studies, an independent think-tank. If the ISA inheritance rules by HMRC preserve the tax wrapper than this means that you will not have any tax liabilities if you inherit the ISA from a partner who has passed on.

The ISA inheritance rules by HMRC will also apply for ISA products such as the Lifetime ISA which allows first-time buyers and those saving for their retirement income to put a maximum of £4,000 a year away and get £1,000 in bonus each year. If a partner with a lifetime ISA dies then according to ISA inheritance rules from HMRC the surviving partner will be given an “additional permitted subscription” equal to the amount held in the Lisa — including any government bonus it had earned. This additional permitted subscription money will no longer be inside a lifetime ISA wrapper and this means that the surviving spouse can withdraw it at anytime without any withdrawal charge. They could simply use the money to pay into their £4,000 a year maximum lifetime ISA contribution.

It may also be possible to pass your ISA within your inheritance threshold without going over the nil band rate.

The only exception to the ISA inheritance rules by HMRC is the Junior ISA, wherein there is no inheritance ISA allowance and any money in the Junior ISA will be paid to whoever inherits their estate.

What are the inheritance tax rules on ISAS?

The inheritance tax rules on ISAs allow your spouse to inherit your ISA and add it to their annual ISA allowance for a particular rate. Anybody else who inherits your ISA may have to pay capital gains or inheritance tax. This is the case for all ISA except junior ISAs which pass on to the estate.

What happens to an ISA when the owner dies?

Once an owner dies their ISA becomes a continuing ISA, no money can be paid into the ISA and it can only be inherited tax-free by the spouse.

A continuing ISA will continue to be so until

The administration of the estate is complete

The ISA is closed

It’s been three years since death”

Can I inherit an ISA?

You can inherit an ISA as long as you are the spouse of the deceased. If you are not then you can still inherit the ISA but may have to pay inheritance tax. You should seek independent financial advice to determine if you can inherit the ISA.

Are ISAS taxed on death?

ISAs can be taxed if anyone other than the spouse inherits them.  If the ISA is part of the nil band rate on inheritance tax then it will avoid the tax but it may still be due capital gains tax upon death. You should seek independent financial advice.

Is inheritance tax payable on ISAS?

If your spouse dies then you will not need to pay inheritance tax on the ISA as you will receive  “additional permitted subscription” which means you can get their ISA balance within a tax-free wrapper for one tax year. This will add to your annual ISA contributions and avoid you paying  income tax, dividend tax and capital gains tax.

Can you transfer an ISA on death?

An ISA can be transferred on death but it can only be done tax-free to the spouse of the deceased.

Can my wife inherit my ISA?

Yes, your wife can inherit your ISA as part of their annual ISA allowance for one year. The only exception is the Junior ISA, wherein there is no inheritance ISA allowance and any money in the Junior ISA will be paid to whoever inherits their estate.

What information do you need to start the ISA inheritance process?

The date of your marriage or civil partnership

Your partner’s date of birth and the date they passed away

Your partner’s address at the time they passed away

Yours and your partner’s National Insurance numbers

What is a continuing ISA?

“When an investor dies, an ISA is reclassified as a ‘Continuing ISA.’ Though no money can be paid into it at this point, it will continue to benefit from the tax advantages of an ISA. This means any interest earned will remain tax-free.

A Continuing ISA remains until either:

The administration of the estate is complete

The ISA is closed

It’s been three years since death”

When the ISA ceases to be a ‘continuing ISA’, the account will no longer be exempt from tax. You will not be able to make any additional subscriptions to the ISA but it can continue to remain invested as long as the ISA managers terms and conditions allow you to do so.

In this blog, we have covered the inheritance rules by HMRC.You should seek expert tax advice if you are concerned about passing down your ISA in your inheritance. If you have any questions or comments please let us know.

John Bate

John has 22 years of experience in financial services. This spans across financial research, financial services (As a qualified mortgage broker and underwriter), financial trading and sales at global investment banks. While working as a publishing research analyst, he covered European bank credit and advised institutional clients on investment strategies at both JP Morgan and Societe Generale. John has passed all three levels of the CFA (Chartered Financial Analyst) programme.