There is a common misconception that Individual Savings Accounts (ISAs) are tax free. They certainly have many tax advantages, but they are NOT free from inheritance tax (IHT) unless you leave them to your spouse or civil partner.
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For more information on how to reduce the inheritance tax you pay please contact our financial advisers on email@example.com for financial advice, or complete our booking form and your local financial adviser will be in touch. Our Lonsdale Wealth Management financial planners offer a free initial financial planning consultation to discuss your financial planning requirements.
Why ISAs form part of your financial planning solution?
Our Lonsdale Wealth Management independent financial advisers recommend our clients use their ISA allowance each year because of the tax advantages ISAs offer. Remember you can invest £40,000 tax-free for a couple and for the 2020/21 tax year you can invest £9000 for your children in a Junior ISA (or Child Trust Fund (CTF) – a child with a CTF must transfer those funds to a Junior ISA and close the CTF before they are eligible to contribute to a Junior ISA).
What tax advantages do ISAs offer?
During your lifetime any interest received on a cash ISA is free from income tax. Similarly, if you receive dividends from stocks and shares held in ISAs these are exempt from dividend tax, regardless of the amount of interest and/or dividends received. Any capital gain made on the sale of a stocks and shares ISA is similarly free from capital gains tax.
If you invest in Alternative Investment Market (AIM) stocks qualifying for Business Property Relief, you don’t pay inheritance tax on your ISAs
Companies that are listed on the Alternative Investment Market (AIM) can qualify for Business Property Relief (BPR). If your ISA is invested in BPR qualifying AIM stocks you will benefit from the ISA’s tax-free growth and income during your lifetime, but the investment should also be free of inheritance tax if you die. The only condition is that you hold the shares for at least two years and still own them on your death.
Investing in AIM shares is NOT suitable for most clients
However, it is worth noting that AIM shares should only be considered by experienced investors. As your ISA would be invested in small companies that are more volatile, less liquid and considered a higher risk than most other investments you could get back considerably less than you invested, and you could lose some or all of your capital.
When do you pay inheritance tax on your ISAs?
If you leave your ISAs to your spouse or civil partner in your will, they will not be subject to IHT because of the spouse exemption. However, it is important to remember that ISAs are NOT otherwise free from inheritance tax. Remember, if you gift ISAs to another beneficiary the ISAs form part of your estate left to non-exempt beneficiaries and could be subject to inheritance tax depending on the overall value of your estate.
‘We make sure that if a client is investing, they use their ISA allowance because of its tax advantages. However, it is a common misconception with some clients that as ISAs are marketed as ‘tax free’ no inheritance tax will be payable on their death. We always review a client’s inheritance tax planning when we offer financial advice to make sure that they will pay as little inheritance tax as possible. As we discussed investing in an ISA that invests in AIM stocks qualifying for Business Property Relief (BPR) would prevent clients paying inheritance tax on their death, but it is not a suitable investment for most of our clients as it is very high-risk and our clients could lose all or part of their original investment. For more information about inheritance tax planning read our Lonsdale brochure – Inheritance Tax - Introductory Guide.’
How can you transfer ISA allowances to the surviving spouse or civil partner?
Since the 2015/2016 tax year a deceased person’s ISA value is given to their surviving spouse or civil partner as a one-off additional ISA subscription allowance (whether or not the surviving spouse inherits the ISA fund themselves. This means that the deceased’s spouse will be entitled to an additional ISA allowance equal to the value of the deceased’s ISAs at the date of their death.
Example of how ISAs can be transferred tax free on a spouse or civil partner’s death
For example, Stephen is married to Jane. If Jane dies leaving all her estate to her husband including ISAs worth £50,000, Stephen (in addition to his own ISA allowance) can use an additional allowance equal to the value of Jane’s ISAs so £50,000. He can either use cash to subscribe for additional ISAs in his name of £50,000 (and must do this within the later of 180 days of the completion of the administration of Jane’s estate or the end of three years after Jane’s death).
Or if the ISAs have remained with Jane’s ISA Manager the whole time Stephen can transfer them into his name without realising them. This must be done within 180 days of the beneficial interest in the ISAs being transferred to him by the executors. This option is only possible where the surviving spouse inherits the ISA funds.
Even if Stephen doesn’t inherit Jane’s ISA funds (she leaves them to the children for example), he still receives a one-off additional ISA allowance of £50,000 that he can make use of with whatever funds he has available.
‘It is really important that if you are coming up to retirement age that you seek financial advice, so you manage your retirement income in the most tax efficient way. It is also important that you set up your financial planning to mitigate any inheritance tax. It is critical that you write a will, but you may need to get financial advice before you do this. For example, if you have ISAs and a defined contribution pension scheme and you want to leave money to both your spouse and your children in your will you could leave your ISAs to your spouse and leave any defined contribution pension scheme to your children. Unlike ISAs a defined contribution scheme can be left to your children and no tax will be payable on transfer if you died before the age of 75. Everyone’s financial situation is different so it’s really important that you take personalised financial planning advice to avoid inheritance tax.’
If you are concerned that you may pay inheritance tax or require advice on your estate planning or your ISA investments please call our Lonsdale financial advisers in Barnet, Hertfordshire on 0208 275 1160, or complete our booking consultation form.
This represents our understanding of the HM Revenue & Customs practice at 15th July 2020. Please note: The Financial Conduct Authority does not regulate tax advice, estate planning or will writing. AIM shares are very high risk investments. You could lose some or all of your capital.