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ISAs and inheritance tax: what you need to know

Written by: Paloma Kubiak
There’s a “fundamental lack of awareness and understanding around inheritance tax” (IHT), especially when it comes to how ISAs are treated after death, new research shows.

Nearly nine in 10 people in the UK are in the dark on the IHT threshold with only 14% of 2,000 people surveyed knowing the current limit, Octopus Investments has revealed.

It also found that only 8% of people know that ISA savings are subject to a 40% IHT charge, with the remainder failing to realise that tax-efficient savings in life aren’t tax free upon death.

The majority of ISA holders in the UK are over 65 – more than 6 million people over 65 in the UK hold an ISA, government statistics show – yet Octopus research reveals that only 6% of people over 60 are aware that ISAs are subject to a 40% inheritance tax charge upon death.

It warns that people could be sleepwalking into leaving an IHT bill for their loved ones by not understanding the charge and it comes as the government forecasts that the tax gain from IHT will increase from £3.8bn last year to £5.6bn in 2020-2021.

What is the IHT limit?

Currently, no IHT is charged on the first £325,000 of an individual’s estate – the value of property, money and other possessions – when they die. Above this threshold, there’s a hefty 40% tax bill.

But if you’re married or in a civil partnership, then on death any of your estate which passes to your spouse does so without any IHT liability. This effectively doubles the amount to £650,000 that a surviving partner can leave behind tax-free.

What happens with an ISA after death?

If you save into an ISA, it means you can grow your money in a tax efficient way. Unfortunately, after death, this benefit ends – unless you’re married or in a civil partnership.

Anyone whose spouse or civil partner died on or after 3 December 2014 is eligible for a one-off additional ISA allowance equivalent to the value of the deceased person’s ISA at the time of death.

As an example, if a person held £50,000 in a cash ISA on death, their spouse or civil partner would be able to make an additional contribution to their ISA of up to £50,000, on top of their own ISA allowance for the year (£15,240 in the 2015/16 tax year).

However, if the same cash ISA were left to another family member or beneficiary, this same rule doesn’t apply and they would lose the tax efficient status of the wrapper, as well as being subject to 40% IHT if the threshold for the estate is exceeded.

The exception to this is an ISA invested in Business Property Relief (BPR) qualifying Alternative Investment Market (AIM) shares. Since 2013, it has been possible to invest into an IHT-free ISA by holding shares listed on AIM that qualify for BPR.

Shares that qualify for BPR fall outside of the scope of inheritance tax as long as the shares have been held for at least two years, and are still held at the time of death.

Octopus said this ISA option could be an “interesting solution for older investors looking to reduce their IHT bill while maintaining the lifetime tax benefits associated with an ISA, which they have built up during their life.”

‘It’s vital to be aware of rules and regulations around tax planning’

Simon Rogerson, CEO of Octopus Investments, said: “Getting financial advice can make a real difference to people’s lives. Our latest research shows just how vital it is to be aware of the key rules and regulations around tax planning so you can make your money work harder for you and help look after those you love when you are gone.

“ISAs remain the ‘go to’ financial product for many people as they look to build up a nest egg in a tax efficient way during their lifetime. But with such a large number of older people investing into them, there is a worrying lack of awareness that ISAs are subject to a 40% inheritance tax charge. ISAs are a great tax efficient investment in your lifetime but more people need to be thinking about how to pass on their hard earned money to their loved ones when they die.” 

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