ISAs are one of the most tax-efficient ways for UK residents to save or invest, allowing up to £20,000 per year in a tax-free wrapper. While ISAs shelter income and capital gains from tax during your lifetime, the tax treatment can change on death, with Inheritance Tax becoming a key concern for those with substantial investments.

What is Inheritance Tax (IHT)?

IHT is a tax charged on the value of an estate when someone dies. The current nil rate band, which is the amount of an estate not subject to IHT, is £325,000. Any amount above this threshold is taxed at 40%, although certain exemptions, such as assets passed to a spouse or civil partner, may reduce the tax due.

Are ISAs subject to Inheritance Tax?

Yes, ISAs are subject to IHT, despite the tax-free status during your lifetime. Upon death, the value of your ISA is included in your estate, and if the total estate value exceeds £325,000, the portion above this threshold is liable for IHT. However, if the ISA is inherited by a spouse or civil partner, it becomes exempt from IHT.

Does Inheritance Tax apply to all types of ISAs?

Not necessarily. While ISAs are generally subject to IHT, there are strategies to reduce or even eliminate this tax on your ISA’s value. By using certain planning techniques, such as the Additional Permitted Subscription (APS) for spouses or civil partners, investing in AIM shares that qualify for Business Property Relief (BPR), or making charitable donations, it’s possible to mitigate the IHT burden on an ISA. See the “How to protect your ISA from Inheritance Tax” section for more details on these methods.

Are Junior ISAs subject to Inheritance Tax?

Junior ISAs, which are held for children under 18, are also subject to IHT. Upon the death of the parent or guardian who opened the account, the Junior ISA’s value is included in their estate. Once the child inherits the account, it becomes part of their own estate, with IHT implications based on the child’s future assets.

How to protect your ISA from Inheritance Tax

There are several strategies to reduce or eliminate the IHT burden on your ISA:

• Spouse or Civil Partner Inheritance: ISAs passed to a spouse or civil partner are free from IHT. They can also benefit from the APS, which allows the surviving partner to inherit the ISA’s value and retain its tax-free status.
• Bed and ISA strategy: This involves selling taxable investments and reinvesting the proceeds into an ISA during your lifetime, thereby shifting assets from a taxable environment to a tax-free one.
• AIM ISAs: Some ISAs hold shares listed on the Alternative Investment Market (AIM), which may qualify for Business Property Relief (BPR). After two years of ownership, the value of these investments could become exempt from IHT, although AIM shares carry higher risks.
• Charitable donations: Donating part of your estate to charity reduces the IHT rate from 40% to 36%, offering a way to reduce the tax burden while supporting charitable causes.

Planning ahead, particularly if you are married or in a civil partnership, can protect the value of your ISA. Strategies such as using APS, investing in AIM shares, or making charitable donations can help reduce the IHT burden on your estate. If you need advice on ISA and IHT planning, our specialist tax team can help.

Common questions asked:

I’ve inherited an ISA from my spouse, what should I do?

If you inherit an ISA from your spouse or civil partner, you can use the Additional Permitted Subscription (APS), which allows you to retain the ISA’s tax-free status. The APS permits you to add the value of the inherited ISA to your own ISA allowance, preserving its tax advantages. It’s recommended to contact your ISA provider for guidance on transferring the funds and ensuring the APS is applied.

I’ve inherited an ISA from a parent, what should I do?

ISAs inherited from a parent do not retain their tax-free status and will be included in the parent’s estate for IHT purposes. Once inherited, the ISA funds will become part of your general savings or investments. You might consider consulting with a financial adviser to discuss effective ways of managing or reinvesting the inherited funds to optimise tax efficiency.

ISAs and Inheritance Tax – A summary

ISAs offer UK residents a tax-efficient way to save and invest, shielding income and capital gains from tax during their lifetime. However, on death, ISAs become part of the estate and are generally subject to Inheritance Tax (IHT) if the estate’s value exceeds the £325,000 threshold. While ISAs are typically included in IHT calculations, certain exemptions apply, such as passing the ISA to a spouse or civil partner, which exempts it from IHT. Additionally, strategies like using the Additional Permitted Subscription (APS), investing in AIM shares that qualify for Business Property Relief, and making charitable donations can help reduce or eliminate the IHT burden on ISAs.

For further information or guidance on ISAs and Inheritance Tax, contact our team today.