Are ISAs Subject to Inheritance Tax in the UK?

Individual Savings Accounts (ISAs) have long been a popular choice for UK savers due to their tax-free benefits. They offer a secure way to grow wealth without paying income tax, capital gains tax, or dividend tax on the returns.

However, many people are unsure about what happens to their ISA after they pass away and whether it remains tax-free for their beneficiaries.

Understanding how ISAs are treated under UK inheritance tax (IHT) laws is essential for estate planning. The way an ISA is taxed after death depends on factors such as the total value of the estate and who inherits the account.

In some cases, ISAs can be transferred without tax implications, while in others, they may become subject to significant charges. Exploring the rules surrounding ISAs and IHT can help individuals plan effectively to protect their wealth for future generations.

What is Inheritance Tax?

Inheritance Tax (IHT) is a tax levied on the estate of a deceased person before their assets are transferred to beneficiaries.

In the UK, IHT is charged at 40% on the portion of an estate that exceeds the tax-free threshold, also known as the nil-rate band.

Key aspects of Inheritance Tax:

• Tax-Free Threshold: The standard nil-rate band is £325,000. If the total value of the estate is below this amount, no IHT is due.
• Tax Rate: A 40% tax applies to any amount exceeding the £325,000 threshold.
• Residence Nil-Rate Band (RNRB): An additional £175,000 allowance applies when passing a main residence to direct descendants, increasing the total tax-free threshold to £500,000 per person.
• Spouse and Civil Partner Exemption: Transfers between spouses or civil partners are completely exempt from IHT.
• Charitable Donations: If 10% or more of the estate is left to charity, the IHT rate reduces to 36% on the remaining taxable estate.
• Seven-Year Rule: Gifts made more than seven years before death are typically exempt from IHT.

Understanding IHT rules allows individuals to plan their estate efficiently and reduce the tax burden on their beneficiaries. Proper financial planning can help maximise tax-free allowances and exemptions.

Are ISAs Subject to Inheritance Tax?

Individual Savings Accounts (ISAs) provide a tax-efficient way to save and invest, offering protection from income tax, capital gains tax, and dividend tax.

While these benefits apply during the account holder’s lifetime, the tax treatment of ISAs changes upon death. Many people assume that ISAs remain tax-free indefinitely, but this is not always the case.

The impact of inheritance tax (IHT) on ISAs depends on factors such as the total value of the deceased’s estate and the identity of the beneficiaries.

In some instances, an ISA can be passed on without any tax implications, while in others, it may become part of the taxable estate, potentially attracting a 40% IHT charge.

What Happens to an ISA When Someone Dies?

When an ISA holder passes away, their ISA becomes part of their estate, similar to other savings, investments, property, or assets.

The funds in the ISA will no longer benefit from tax-free growth but will remain in the account until the estate is settled. The way an ISA is handled after death depends on whether the account holder left a will or not.

How is an ISA Distributed?

• If a will is in place – The executor, appointed in the will, is responsible for managing the estate, including closing the ISA and distributing its funds to the named beneficiaries.
• If there is no will – The ISA is handled according to intestacy laws, which typically means the next of kin (such as a spouse, civil partner, or children) will inherit the assets.
• If no action is taken – Most ISA providers will automatically close the ISA three years and one day after the date of death, transferring the funds to the estate.

What Happens to the ISA During the Estate Administration Period?

• The ISA remains open and continues to generate interest or investment returns. However, stocks and shares ISAs may also experience market fluctuations, meaning the value could rise or fall.
• The ISA is still considered part of the estate for inheritance tax (IHT) purposes, and tax may be payable depending on the total estate value.
• If the ISA includes an insurance policy, the payout will be made upon the holder’s death rather than when the account is closed.

Once the estate is settled, and any applicable inheritance tax or administration fees are paid, the remaining ISA value is transferred to the designated beneficiary. Unlike normal ISA withdrawals, beneficiaries will not have to pay income tax, dividend tax, or capital gains tax when receiving the funds.

Do Spouses or Civil Partners Pay Inheritance Tax on ISAs?

One of the key exemptions in inheritance tax law applies to surviving spouses and civil partners. Under the spouse exemption rule, any assets, including ISAs, left to a spouse or civil partner are not subject to IHT.

Additionally, the surviving spouse or civil partner can benefit from the Additional Permitted Subscription (APS), which allows them to inherit the ISA’s tax-free benefits. This means:

• The surviving partner can contribute an amount equal to the deceased’s ISA value to their own ISA without it affecting their annual ISA allowance.
• The inherited ISA funds remain tax-efficient, continuing to benefit from tax-free interest, dividends, and capital gains.
• The APS allowance must be used within a specific timeframe, depending on the type of ISA.

This exemption provides significant tax advantages for married couples and civil partners, ensuring that the ISA’s benefits continue without an additional tax burden.

Do Other Beneficiaries Have to Pay Inheritance Tax on ISAs?

If the ISA is passed to beneficiaries other than a spouse or civil partner, the tax situation changes. The key factors influencing whether inheritance tax applies include:

• Total value of the estate – If the estate is valued below the £325,000 inheritance tax threshold, there is no IHT payable. However, if the total estate value (including the ISA) exceeds this amount, a 40% tax applies to the portion above the threshold.
• Who the beneficiaries are – Unlike spouses and civil partners, children, relatives, and friends do not receive an automatic tax exemption on inherited ISAs. The ISA funds lose their tax-free status upon inheritance and are treated as part of the taxable estate.
• Residence nil-rate band (RNRB) – If the deceased owned a home and passed it to direct descendants, an additional £175,000 exemption may apply, potentially reducing the IHT liability.

Example of how inheritance tax applies:

Beneficiaries who receive an ISA as part of an estate should seek financial advice to understand their tax obligations and potential strategies to minimise IHT liabilities.

How Can Estate Planning Help Reduce Inheritance Tax on ISAs?

Effective estate planning can help reduce the inheritance tax burden on ISAs. Some key strategies include:

• Gifting assets before death – Gifts made more than seven years before death are not subject to IHT. However, gifts made within seven years may still be partially taxed under the taper relief system.
• Using trusts – While ISAs generally cannot be placed in trusts, other financial assets can. Trusts can help reduce the taxable estate and control how wealth is distributed to beneficiaries.
• Making use of tax-free allowances – Annual gifts of up to £3,000 per year are exempt from IHT and do not count toward the estate’s value.
• Investing in Business Relief (BR)-qualifying assets – Some investments, such as AIM ISAs, may qualify for 100% IHT relief if held for at least two years before death.
• Utilising life insurance policies – Life insurance can be used to cover potential IHT liabilities, ensuring that beneficiaries do not need to sell assets to pay the tax bill.

By carefully structuring an estate, individuals can significantly reduce the inheritance tax burden on their ISAs and other financial assets.

Are There Any ISA Types That Are Exempt from Inheritance Tax?

Most ISAs are subject to IHT, but AIM ISAs (which invest in Alternative Investment Market shares) may be eligible for Business Relief (BR). If an AIM ISA meets the BR qualification and has been held for at least two years, it can be passed on inheritance tax-free.

However, AIM ISAs come with significant investment risks:

• Higher volatility – AIM-listed companies are typically smaller and more volatile than stocks in the main market.
• Liquidity risks – Shares in AIM-listed companies may be harder to sell quickly.
• No guaranteed IHT exemption – The BR qualification rules can change, and not all AIM shares qualify for IHT relief.

Before considering an AIM ISA as an inheritance tax planning tool, individuals should seek professional investment advice.

What Are the Rules for Transferring an ISA After Death?

The process of transferring an ISA after death involves several key steps:

1. Notification of death – The ISA provider must be informed, and they will typically require a death certificate and proof of estate administration.
2. Account freezing – The ISA is frozen, and no further contributions can be made. However, it may continue to earn interest or returns on investments.
3. Distribution of funds – The ISA value is either transferred to the surviving spouse or civil partner under APS rules or distributed as part of the estate to other beneficiaries.
4. Tax assessment – If the estate exceeds the IHT threshold, the ISA’s value is included in the taxable estate, and tax may be payable before distribution to beneficiaries.

This process can take several months, depending on the complexity of the estate and any legal requirements.

Can You Inherit an ISA and Keep Its Tax-Free Status?

ISAs lose their tax-free status upon inheritance unless inherited by a spouse or civil partner through the APS system. For all other beneficiaries:

• The funds are transferred out of the ISA and become subject to tax on future interest, dividends, or capital gains.
• Beneficiaries can reinvest the funds in their own ISA, but this will count towards their annual ISA contribution limit (£20,000 in 2024).
• If the ISA is part of a larger estate that exceeds the IHT threshold, the funds may also be subject to 40% inheritance tax.

Planning ahead can help beneficiaries maximise the value of their inherited ISAs while minimising tax liabilities.

How Can You Minimise Inheritance Tax on ISAs?

To reduce inheritance tax exposure on ISAs and other assets, consider the following strategies:

• Utilising the spouse exemption – Leaving ISAs to a spouse or civil partner avoids IHT.
• Making tax-free gifts – Gifts within the £3,000 annual exemption or larger gifts given at least seven years before death may be IHT-free.
• Investing in Business Relief-qualifying assets – AIM ISAs can provide potential IHT relief if held for two years.
• Taking advantage of the residence nil-rate band – If applicable, this can increase the IHT-free threshold to £500,000 for individuals and £1 million for married couples.
• Seeking professional financial advice – An experienced estate planner can help develop a tax-efficient inheritance strategy.

By implementing these measures, individuals can help protect their wealth and ensure that more of it is passed on to their chosen beneficiaries.

Conclusion

ISAs are a valuable savings tool during life, but they do not automatically remain tax-free after death. Whether or not an ISA is subject to inheritance tax depends on the value of the deceased’s estate and the identity of the beneficiary.

While spouses and civil partners can inherit ISAs tax-free through the APS system, other beneficiaries may face a 40% IHT charge if the estate exceeds the threshold.

Effective estate planning, including gifting assets, using trusts, and exploring AIM ISAs, can help mitigate inheritance tax liabilities. Seeking professional advice is essential to ensure your financial affairs are managed efficiently.

FAQs

Are ISAs included in the taxable estate?

Yes, ISAs are included in the deceased’s taxable estate and may be subject to inheritance tax if the estate exceeds the IHT threshold.

What is the inheritance tax threshold in the UK?

The current IHT threshold is £325,000, with assets above this amount taxed at 40%.

How does Additional Permitted Subscription (APS) work?

APS allows a surviving spouse or civil partner to inherit the deceased’s ISA value and continue benefiting from its tax-free status.

Can you put an ISA in a trust to avoid IHT?

ISAs generally cannot be placed in a trust. However, other estate planning strategies, such as gifting and Business Relief investments, may help reduce IHT.

What happens if an ISA holder dies without a will?

If there is no will, the ISA is distributed according to intestacy laws, which may not align with the deceased’s wishes.

Do Junior ISAs (JISAs) have inheritance tax implications?

Yes, JISAs form part of the deceased’s estate and may be subject to IHT if the estate exceeds the threshold.

Is it possible to transfer an ISA to a charity to avoid IHT?

Yes, leaving an ISA to a registered charity can be IHT-exempt and may reduce the taxable estate.