Inheritance and the tax surrounding it can seem complicated. And during the difficult time of having lost a loved one, thinking about the related paperwork is probably the last thing on your mind.
But if you know you’re likely to inherit an ISA in the process of settling the estate, this guide will give you insight into what to expect and how it all works.
Inheritance is the act of passing on your assets to your family, friends, or other parties like a charity.
It could come in the form of things like property, land, jewellery, antiques, money, or stocks and shares.
If you’re reading this article, it’s positive that you’re already taking proactive steps to understand the process.
The rules are different depending on your relationship with the individual.
For example, a spouse may see the ISA being passed in a different manner to their child. You can jump straight to the relevant part you need answers for here:
- What happens to an ISA when you die?
- Are ISAs subject to Inheritance Tax?
- Types of ISAs that can be inherited
- Inheriting an ISA from a parent or spouse
- Can I transfer an Inheritance ISA to another provider?
- Protecting your ISA from Inheritance Tax
What happens to an ISA when you die?
ISA stands for ‘Individual Savings Account’, and they give the person the opportunity to save or invest up to £20,000 in each tax year, until their time of death.
When the person who owns the ISA passes away, someone new can’t continue to deposit into it — even if they inherit the money.
There’s no such thing as a joint ISA, but if you are the spouse or legal civil partner of the ISA’s owner, the money is usually transferred over to them. However, the couple must have been living together and not ‘estranged’ at the time of death.
This type of transfer comes with an additional benefit called the Additional Permitted Subscription (APS). This means the spouse or civil partner can inherit the ISA and add it to their own ISA allowance for that tax year.
An example of Additional Permitted Subscription (APS):
Let’s say a husband had an ISA with £84,000 saved, including interest that’s built up over the years. After his death, the entirety of the ISA’s value can be transferred to his wife (who he lived with) and as a one-off.
In this example, she could keep her own entitlement to save/invest £20,000 tax-free in an ISA that year, plus add the £84,000 to the total.
There would be no capital gains or income tax to pay when she withdraws her money, including the £84,000 of her husband’s ISA money. At the event of her death, the total could then be subject to Inheritance Tax, depending on the value of her remaining estate.
If the husband had a Stocks and Shares ISA and they’d like to transfer the existing investments (rather than selling them to transfer as cash), this is possible if the wife uses the same ISA provider.
Closing the ISA
The ISA in question can be closed in a couple of ways:
1. The executor of the estate (the person who is dealing with their belongings, property, and money) can close it.
2. When the estate’s administration is finalised and complete.
3. If the above two still haven’t been actioned, three years and one day after the person passes away, the ISA provider would close the account.
Up until that point (whichever of the above), there is no capital gains or income tax to pay.
However, if there are investments involved, those will need to be counted as part of the estate’s value for calculating Inheritance Tax (IHT).
Are ISAs subject to Inheritance Tax?
Yes, ISAs and any of their interest/gains built up in the person’s lifetime would be considered part of their estate (all their assets like property and money etc.).
However, the general rule of Inheritance Tax (IHT) is that if the value of the person’s estate is below £325,000, there’d be no Inheritance Tax to pay.
And if the estate’s value is over £325,000, there’ll be no Inheritance Tax on anything above that amount if it’s going to their civil partner, spouse, charity, or community amateur sports club.
A ‘continuing account of a deceased investor’
The tax-free status of an ISA (defined as it being free from capital gains tax or income tax during their lifetime), can continue after the person has passed away until:
- The estate is settled.
- The account is closed.
- Or it’s been three years and one day since their passing.
This means the interest and/or gains can continue for a while until things have settled. However, any accidental payments made after the date of death and its interest (e.g. a Direct Debit that hadn’t been cancelled in time) would be removed by the ISA Manager [1].
If the money is passing to a different family member, close friend, charity or club, they probably won’t have to foot the bill themselves in a manual sense.
The ISA Manager (Wealthify, in this example) would be instructed to close the account and pay any Inheritance Tax forward to HMRC, before transferring the remainder to the beneficiary.
Types of ISAs that can be inherited
In the UK, there are four types of ISAs that adults can have (not including the Help to Buy ISA that’s been phased out in recent years):
- Stocks and Shares ISAs for investing.
- Cash ISAs for saving money.
- Lifetime ISAs, which can be used for either saving or investing. They’re usually used for the deposit of a first home or as a personal pension pot.
- Innovative Finance ISAs, for investing in alternative things like peer-to-peer lending.
The money builds inside the account, including any interest or profit that is made.
The individual’s money is not subject to capital gains tax or income tax when the time comes to withdraw; ISAs are often called ‘tax-free’ for this reason, but tax treatment is based on an individual’s personal circumstances.
However, ISAs for cash savings and investments are treated differently when it comes to inheritance: existing investments are counted towards the value of the person’s estate (you’ll see this called ‘in-specie’; check with your provider about whether this is possible). Stocks and Shares ISAs and Innovative Finance ISAs are applicable in that instance, as well as a Lifetime Stocks and Shares ISA.
There’s also something called a Junior ISA, which a parent or guardian might manage to save or invest for their child until they turn 18.
Once the child turns 18, the Junior ISA matures into an adult ISA in their own name. If the child has passed away, their money would either go towards their estate (usually their parent or guardian). If they were 16 or over and married/in a civil partnership, it would go to their legal partner [2].
Lifetime Cash ISAs or Lifetime Stocks and Shares ISAs can be passed on through inheritance, including any government bonus or interest that’s accrued. For the Lifetime Stocks and Shares ISA, any investments are included in the estate’s valuation.
Whereas the older Help to Buy ISAs don’t pass on any government bonus entitlement when inheriting (which doesn’t get paid until the property purchase is finalising, anyway).
Inheriting an ISA from a parent or spouse
I’m a spouse or civil partner
The Additional Permitted Subscription (APS) transfer that we mentioned earlier is available to you, as long as you were living together at the time of death and considered to actively still be a couple (not separated).
Keep in mind the time limits: for ISAs that are holding cash, you have three years from the date of death or after the estate’s administration is complete.
For transferring existing investment assets ‘in specie’ style, you can have those transferred to your own ISA account within 180 days. Don’t forget you’ll need to have the same ISA provider as the deceased for this to be completed — but do contact the provider to confirm things first [3].
Wealthify does not offer in-specie APS transfers. However, you can choose to sell the investments and transfer them to us under APS as cash (after which, we can reinvest for you if you choose a Stocks and Shares ISA).
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
I’m the child of the deceased
If you’ve been told you’re the beneficiary of an ISA in the will, you can inherit the sum, minus any Inheritance Tax (IHT) that may be deducted before it reaches you. The standard rate of IHT is 40%.
Keep in mind the Inheritance Tax thresholds though: if their estate is worth less than £325,000, there should be no IHT to pay.
If you’re also inheriting their property in the will, this threshold goes up to £500,000 as you are their child (as long as the overall estate is valued below £2 million).
If the estate is over the £325,000/£500,000 thresholds (whichever is applicable), it’s only the portion above the threshold that will be charged 40% tax.
Can I transfer an Inheritance ISA to another provider?
If you’re the spouse or civil partner, once the inherited ISA is in your ownership, you are free to transfer that to another ISA provider that’s better suited to you. However, be sure to check for and take any exit fees from the existing provider into consideration.
It’s worth using the new provider’s official ISA transfer process (usually a form), which allows them to move the money over (including the ‘tax-free wrapper’). This means you can continue to save or invest in the current tax year with your remaining £20,000 ISA allowance.
Remember, if you’re the spouse/civil partner and you want to keep the specific investments (such as stocks and shares), those APS transfers must be with their existing provider. But if you want to instruct for those to be sold and proceed with the Additional Permitted Subscription transfer for cash, you need to:
- Check the new provider accepts APS transfers (as not all do; Wealthify accepts cash APS transfers).
- If they do, ask the deceased’s current ISA provider for an ‘APS certificate’.
- You can then give the certificate to the new provider. They may ask to see the death certificate and ask you to complete any relevant forms — you can decide at this point whether or not to transfer over to a different type of ISA (i.e. transferring from a Cash ISA into a Stocks and Shares ISA).
Overall, it’s essential to check the existing ISA provider and the new one’s terms and conditions.
It may be worth reaching out to their customer service team before you make a decision (here’s a link to Wealthify’s Help Centre if you need it).
Protecting your ISA from Inheritance Tax
If your loved one’s estate is going to be over the Inheritance Tax threshold, the 40% tax on anything above the threshold could seem quite a significant amount. There are strategies to help manage the tax bill and make sure you’re paying the correct amount.
Take advantage of the Additional Permitted Subscription
If you’re the current spouse or civil partner and were living with the deceased, this is the most obvious way to transfer the money over to your own ISA and keep your remaining ISA allowance for the current tax year.
If you already have an existing ISA, ask the provider if they accept Additional Permitted Subscriptions. If they can and you’re happy with the provider’s service so far, you can instruct them to start the process.
However, it’s worth doing some research into their fees at this stage, especially if your partner’s money will significantly increase the size of your ISA. Also, check the exit fees of your current provider, in case you decide to transfer it to another provider in the future.
At Wealthify, for example, we don’t charge for transfers in or out, and our annual platform fee is 0.6% for all our products. For our Stocks and Shares ISA, the ongoing fees can vary depending on the Investment Plan you choose (Original or Ethical). We usually estimate it to be 0.16%-0.7% per annum, but feel free to use our fees calculator.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
Understand the rules around gifting money
At this time, you may be concerned about some money that your loved one has given you in the past and whether it will be liable for Inheritance Tax now. Help from a parent for large purchases (such as a first home deposit) can weigh heavy on the mind at this time.
Here are the kinds of things that can be considered ‘gifts’:
- Money for the receiver to spend, save, or invest.
- A property, including a house, land, or other buildings.
- Stocks and shares on the London Stock Exchange.
- Any unlisted shares that they’ve held for less than 2 years before the person passed away.
- Jewellery, antiques, furniture, or any other household/personal goods.
In the UK, you can gift a total of £3,000 in every tax year completely tax-free (gifted to one person or spread between multiple). You can also roll over any unused gift allowance from the previous year as a one-off (so, £6,000 on that occasion).
If you’re gifting money towards a special occasion like a wedding or entering a civil partnership, this gift is an additional exception to the rule. A person could gift:
- £5,000 to their own child.
- £2,500 to their grandchild or great-grandchild.
- £1,000 to anyone else.
On top of this, you can gift £250 for a loved one’s birthday or Christmas if it comes from your regular income.
It’s also okay to give as many £250 per person gifts as you want each tax year, as long as you have not used another allowance on the same person.
And it’s also fine for them to have been giving you support for your rent or living expenses, as long as it was from their own regular income [4].
The seven-year rule: when Inheritance Tax is no longer applicable
Technically, you could give any sum of money to someone if you hope to live for the next seven years, and the receiver will not be subject to Inheritance Tax after that point (not including money held in trusts).
So, in theory, a parent could gift their entire wealth to their child in small increments using the £3,000 annual gift allowance, or as a lump sum in hopes that they wouldn’t pass away in the following seven years.
Further to this, the amount of Inheritance Tax that is payable does lower as years go by.
- If your loved one gave you a gift in the past 3 years, you would be liable to pay 40%.
- However, at years 3 to 4, the IHT rate drops to 32%.
- Then 24% in years 4 to 5.
- 16% in years 5 to 6.
- 8% in years 6 to 7.
- And once it’s past 7 years, it drops to 0% and is no longer liable for Inheritance Tax.
Understandably, this is likely a very difficult time, so try to put your mind at ease by remembering that Inheritance Tax only applies if the person’s estate is valued over the £325,000 threshold (or £500,000 if a deceased parent has left their property to their child).
Only then would it be typically charged, and that tax bill is against the portion that’s over the threshold (40% against the full estate’s value). Additionally, if the money is held in an ISA, your ISA Manager will deduct any amount for the tax bill before the money arrives in your account.
Moving money into a trust
Following on from the seven-year rule, some people may opt to preemptively protect their children or other loved ones from an Inheritance Tax bill by moving it into a trust and naming them as the beneficiary.
While the money will no longer get the tax-free benefits that come with an ISA, from the point of moving it over to the trust, it is working towards a time (post-seven years) that it can be considered free from Inheritance Tax liability for the beneficiary. It comes down to things like the overall value of the estate including everything held in trusts, whether a 20% Inheritance Tax was paid upfront, and the amount of time that’s passed since the trust was set up. Read the HMRC website for more information.
Trusts can be complicated to calculate, and there are a variety of options. See the MoneyHelper website for a more detailed breakdown of the types of trusts available.
Even if your loved one hadn’t set up a trust for you, you can at least be prepared with the knowledge of how this works when you plan to pass on your own money to a loved one in the future.
Speak to an independent financial advisor
We don’t give financial advice at Wealthify, so it’s important that you seek specific guidance on these matters from a professional, including a financial advisor and the solicitor that’s settling the estate for you.
Between both parties, they should be able to help you look over these financial matters with clarity and guidance that’s specific to your family’s exact circumstances, especially during such an emotionally sensitive time.
With their help, you should be able to ensure your Inheritance Tax is in the correct bracket and tapered tier, if gifts have been given in the past seven years.
Your tax treatment will depend on your individual circumstances, and it may be subject to change in the future.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.
Wealthify does not provide financial advice. Please seek financial advice if you are unsure about investing.
References:
1: https://www.gov.uk/guidance/close-void-or-repair-an-isa-if-youre-an-isa-manager
2: https://www.gov.uk/junior-individual-savings-accounts/if-your-child-is-terminally-ill-or-dies
3: https://www.gov.uk/individual-savings-accounts/if-you-die
