What is Inheritance Tax (IHT)?
Inheritance Tax (IHT) is a tax payable on the value of a deceased person's estate, which includes money, possessions and property. IHT is usually payable on everything above £325,000, a threshold frozen until April 2028.
The amount up to the £325,000 threshold is known as the 'nil rate band'. Once the value of an estate exceeds this, there is a 40% tax on the rest. Additionally, there's a main residence nil rate band, which you can read more about here.
Many people's estates include savings and investments wrapped up in ISAs. So, what would happen to your ISA if you were to die? And is it subject to inheritance tax?
What happens to my ISA when I die?
When you pass away, your ISA will form part of your estate. It will be treated in the same way as any other savings, investments, property or assets you have.
This means it can be left in a will, or, if you haven’t made a will, can be distributed in accordance with the rules of intestacy. This usually means your next of kin will inherit everything.
Depending on the type of investments* held in your ISA, when you die it will remain open until:
- The person appointed to carry out the terms of the will (executor) closes it
- The administrator (where there is no will) closes it upon completion of estate administration
Or, where neither has occurred,
- The ISA provider closes it, three years and one day after the date of your death.
Between the date of death and closure of the ISA, any growth or interest will continue to accumulate, along with the potential for a stocks and shares ISA's value to fall.
Once the ISA has been closed and any relevant fees or Inheritance Tax have been paid, its value will be passed on to whoever the beneficiary is. It won't be liable for income, dividend or Capital Gains Tax.
*If the ISA holds an insurance policy, it will pay on the date of your death.
Increasing an ISA allowance
If you're the spouse or civil partner of somebody who has passed away, you can increase your own ISA allowance for a single tax year. The amount you can increase it by is the equivalent of what was held in their ISA, either when they died or when the ISA was closed. This is possible, even if the ISA itself is passed on to somebody else.
The value can be added once only, without impacting your ISA allowance (£20,000, as of the 2023/24 tax year).
So, if the deceased's ISA contained £7,500, you would be able to place up to £27,500 into an ISA that year, without having to pay tax on any returns.
Are ISAs exempt from Inheritance Tax?
Whether an ISA is liable for Inheritance Tax depends on who the beneficiary is. If you are the spouse or civil partner of the deceased, then there is no IHT to pay. This is due to the spouse exemption rule, which means an estate can be passed on to the husband, wife or civil partner, without the need to pay tax.
If the beneficiary of the ISA is anybody other than a spouse or civil partner, there may be Inheritance Tax to pay. This will depend upon the total value of the estate.
The current threshold is £325,000, with 40% IHT usually paid on any value above that. Efficient estate planning, however, can help to minimise the tax liability on your family.
Are payments into a junior ISA subject to Inheritance Tax?
Depending on the circumstances, payments into a junior ISA may be subject to Inheritance Tax. If you've been contributing to a junior ISA for your child or grandchild and you leave an estate worth more than £325,000, then rules surrounding 'gifting' will apply.
- Annual inheritance tax exemption – You can give gifts of up to £3,000 each year, without incurring IHT. This amount covers all types of gift, whether monetary or possessions and, in this instance, would be spread across however many junior ISAs you were paying into. The exemption also carries over for a single year. So you could pay £2,000 into a junior ISA one year and, as long as you didn't gift anything else that year, the remaining £1,000 would be added onto the IHT exemption for the next financial year (making £4,000 in all).
- Small gift allowance – A small gift allowance of £250 is also available per person, per year. It can't be used on somebody you've already used an allowance on though. So, if you paid £3,000 into a child or grandchild's junior ISA, you cannot then pay an extra £250 into it and expect it to be exempt from Inheritance Tax.
- The seven-year rule – If the money was paid into the junior ISA seven or more years prior to your death, there will be no Inheritance Tax to pay on it.
- Normal expenditure out of income - You can make regular payments into a junior ISA out of your net disposable income without it being considered a gift. HMRC judges what is considered 'normal' on a case-by-case basis, but generally it would be normal expenditure for you, not for the average person, without adversely impacting on your own financial situation.
You can find out more about junior ISAs here.