Article

Are ISAs subject to inheritance tax?

The favourable tax treatment of ISAs does not extend to inheritance tax (IHT). They count as part of your estate for IHT purposes with certain exceptions.

| 7 min read

Individual Savings Accounts (ISAs) are popular with investors and savers looking to protect returns from tax. There is no tax to pay on any profits on investments housed in a Stocks & Shares ISA and no tax on any income or interest, so many people assume their ISA would be exempt from inheritance tax (IHT) too. However it’s important to remember that ISAs count as part of your estate - and the favourable tax treatment does not extend to IHT.

If your combined assets including your ISAs are over the relevant threshold then your estate would have to pay the tax – but there are a couple of exceptions.

How can you manage ISAs subject to inheritance tax?

Hands with calculator

1. Inherited ISA allowance from your partner

The main exception is that assets left to a spouse or civil partner are free from IHT. Where a husband leaves their ISA, or other assets, to their wife, or vice versa, there is no tax to pay. However, IHT may subsequently become an issue on the death of the second spouse who inherits any of their partner’s remaining IHT ‘nil rate band’, the portion of an estate that is free from IHT.

What’s more, no matter how the assets are divided according to the specifications of the will (or if there isn’t one, according to the rules of intestacy) in most cases a surviving spouse or civil partner can inherit the tax benefits of all the deceased’s accumulated ISAs through 'additional permitted subscriptions'.

Introduced in April 2015, the value of an APS (the sum of all ISAs held in the deceased’s name) can be made to a new or existing ISA in addition to their annual ISA allowance.

If there is no surviving spouse or partner, and the assets are left to another beneficiary such as a child, there is no APS available and the benefits of the deceased’s accumulated ISA ‘wrappers’ cannot be passed on. This means the beneficiary will not benefit from tax-free income and growth from the assets and they may have to declare this in their tax return. However, they could look to sell and repurchase the investments in an ISA using their own £20,000 a year ISA allowance in a process known as a ‘Bed and ISA’.

Follow the link for more information on additional permitted subscriptions and what would happen to your ISA if you passed away.

2. Consider AIM ISAs as they are free from IHT

Another exception to the rule is investing in shares listed on the UK’s Alternative Investment Market or AIM. AIM was launched in 1995 to provide a platform for smaller growth companies to raise capital without having to adhere to the tighter and more costly regulations that a listing on the main London Stock Exchange entails.

Certain AIM shares, whether held inside or outside an ISA, qualify for Business Property Relief (BPR) which means they can be passed onto your heirs IHT free. That’s provided you hold the shares for at least two years, they are still held on death,and the company still qualifies for the relief at that point. If the two-year period is not met, a surviving spouse or civil partner can inherit the portfolio without restarting the holding period.

There is no limit to how much you can hold in BPR-qualifying shares, but investors should be willing and able to accept the high risks that come with the market. AIM is home to some larger, profitable and cash-generative businesses that have become leaders within their fields, as well as less-established, innovative companies with significant potential. However, many AIM-listed businesses are at an early stage of their development with limited earnings. It can be something of a minefield with some businesses very high risk and likely to fail at some stage, resulting in investors losing all or a large portion of their investment.

Share prices on AIM also typically experience greater ups and downs than those on the Official List of the London Stock Exchange, and they often have a wide ‘spread’ or difference between buying and selling prices. At times, it may be difficult or impossible to sell certain shares.

3. Find out which AIM shares qualify for BPR

HMRC sets rules on which companies qualify for BPR and if you are an investor in single shares you may already have eligible AIM investments that stand to benefit from this tax break. Besides being a trading company not listed on a main stock exchange, the main exclusion is companies that mainly deal with investments, land or buildings. When a claim for relief is made during probate HMRC confirms if any shareholdings qualify for BPR and whether the shares can be passed on free of IHT.

For DIY investors one ‘hands-on’ option is to research shares yourself for their investment potential and BPR-qualifying status. However, this is a complex process and is not recommended unless you are proficient at analysing and selecting companies. An alternative is to invest in a ready-made AIM ISA portfolio of qualifying shares managed by a professional manager. This spreads your investment across a range of companies to help reduce risk, although any portfolio comprising AIM shares or smaller companies more generally should still be considered higher risk.

Inheritance tax planning at Charles Stanley

Elderly couple organising their inheritance tax affairs with a professional

The Charles Stanley Inheritance Tax Portfolio Service is available through our financial advisers and can be a consideration for those who have not put in place long-term plans for their estate. The investments can become exempt from IHT after just two years compared with seven years for a trust or gift, based on current tax relief and legislation.

Various inheritance tax mitigating strategies involve giving up some control and ownership of assets, which to many feels uncomfortable and irreversible. When investing directly in AIM, an individual retains control and has the ability to distribute the income generated, or liquidate part, or all, of the portfolio at any stage. As this is only one of many techniques that can be used to mitigate inheritance tax, clients need to seek financial advice regarding their inheritance tax liability before using the service. Remember, IHT planning can be complex, tax rules can change, and benefits depend on circumstances.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

How much inheritance tax could you pay?

Use our handy Inheritance Tax Calculator for an estimate of how much your IHT bill would be.

Inheritance Tax Calculator

More insights

Article
Junior ISAs – the secret inheritance tax weapon
By Aaron Gibbs
Personal Finance Commentator
23 Jan 2024 | 7 min read
Article
Investment ideas for your ISA allowance
By Rob Morgan
Spokesperson & Chief Analyst
11 Jan 2024 | 13 min read
Article
Seven tips for using your ISA allowance
By Rob Morgan
Spokesperson & Chief Analyst
04 Jan 2024 | 9 min read
Article
ISA or pension? Here’s how both could rescue your retirement
By Russell Miles
Senior Personal Finance Commentator
28 Dec 2023 | 7 min read

The information in this article is based on our understanding of UK Legislation, Taxation and HMRC guidance, all of which are subject to change. The tax treatment of pensions depends on individual circumstances and is subject to change in future. This article is solely for information purposes and does not constitute advice or a personal recommendation.