ISAs are not shielded from inheritance tax

I read your piece about making gifts for inheritance tax purposes and I wanted to ask you about my Isa savings. I have built up a significant amount across cash and stocks and shares Isa.

Are they subject to inheritance tax and income tax? Should I be putting them in my wife’s name now?

Name and address supplied

Gareth says…

Your estate is the accumulation of the things you own – your possessions, property, investments and savings. Most of these assets are liable for inheritance tax – pensions are notably excluded, along with some gifts as I discussed recently.

That means, however, that any savings you have in your Isa are potentially subject to inheritance tax. The Isa protects your savings from income tax, capital gains tax and dividend tax, but does not shield your heirs from inheritance tax.

That doesn’t necessarily mean that 40 per cent of the savings you’ve built up are going to be wiped out when you die. Inheritance tax is only payable if your estate exceeds £325,000 (or £500,000 if it includes your main home which is to be inherited by children or grandchildren).

And there are special rules for Isas which will allow you to preserve their tax-free status to an extent.

Transferring the Isas to your wife could end up costing you money in the long run. While you can transfer your savings from one Isa account to another while keeping them protected against tax, you cannot transfer an Isa from your name to your wife’s. You’d have to withdraw the money and encash any investments, taking them out of the Isa ‘wrapper’. Then, when your wife comes to reinvest the savings, she’ll be limited to placing £20,000 a year into an Isa.

You could, of course, do this on an annual basis until your savings have been fully transferred over and your wife has put them all in an Isa. But you’ll face costs for selling investments, potential charges for closing a stocks and shares Isa, and time out of the market which could affect the value of your savings.

There’s good news. When you die, your wife will be able to inherit your Isa savings through something called an ‘additional permitted subscription’. This will provide her with an additional Isa allowance, beyond her own £20,000 annual limit, equivalent to the value of your savings, which will allow her to place all your savings into her own Isa.

Let’s suppose you have £100,000 in your Isas. When you die, your wife will get a one-off £100,000 Isa allowance, in addition to her £20,000 allowance. This applies even if you decide to give the actual cash in your Isas to someone else in your will. If you left £50,000 to a child and £50,000 to your wife, she’d still get the £100,000 additional Isa allowance. Growth in the value of your Isas after your death will also form part of the additional subscription.

Your wife will have a range of options – she could keep the savings and investments with your existing providers, or open new accounts. Not all Isa providers accept this additional allowance, however – Which? research has found that less than half of cash Isa providers accept the additional subscription.

That doesn’t mean there is nothing to choose from, as more than 100 accounts exist that accept the allowance. Some providers have launched special inheritance Isas for exactly this purpose – you can find a list, along with rates, on which.co.uk/inheritisa.

With stocks and shares, there are a couple of options. She could sell your investments for cash, allowing her to reinvest them in a new stocks and shares Isa, or she could carry out an ‘in specie transfer’ which allows the investments to be transferred without being sold.

There is a time limit to claim this additional allowance but it’s quite long – your wife will have three years to claim it after the date of your death.