Isas and inheritance tax: How does it work?

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Is an Isa protected from inheritance tax? Millions of over-55s unsure of the rules around the tax-free wrapper and passing on wealth

  • A third of over 65s want to pass on their Isa pots to family members  
  • Three quarters have never checked inheritance tax rules 
  • It means millions are unaware that family members could face a hefty bill  


Little researched inheritance tax rules for Isas means millions are unprepared to pass on wealth and as a result, their beneficiaries could be hit with an unexpected bill later down the line.

Isas are a tax-efficient way to invest your cash without paying tax on your returns. You can invest up to £20,000 per tax year.

However, if you plan to pass these savings on to a family member the tax implications are not as favourable.

Isa confusion: Millions of Brits are unaware of inheritance tax rules meaning their family members could face a hefty bill

Isa confusion: Millions of Brits are unaware of inheritance tax rules meaning their family members could face a hefty bill 

If your spouse or civil partner dies you can inherit their Isa allowance under rules introduced in 2015. 

As well as your normal Isa allowance you can add a tax-free amount up to either the value they held in their Isa when they died or the value of their Isa when it’s closed.

But if you have plans to pass the Isa on to children, grandchildren, siblings or friends – which a third of over 55s do – it could leave them with a  chunky tax bill.

Current rules stipulate that if you plan to pass your savings on to the next generation, and all assets exceed the £325,000 IHT allowance, beneficiaries could be left with a 40 per cent tax charge.

Millions of over 55s are unfamiliar with IHT rules relating to Isas despite plans to pass them on to the next generation, according to research from Octopus Investments.

Almost three quarters of over 65s in the UK have never checked IHT rules and 17 per cent are unaware of what the threshold is.

With house prices rocketing to a record high of £260,320, according to Nationwide, more estates will risk breaching the threshold.

The research found that one in five over 65s are already near to, or over the threshold, with the group owning one or more properties and over £100,000 of assets.

Jess Franks of Octopus Investments says: ‘Inheritance tax is not widely understood and can therefore get overlooked when it comes to financial planning. 

‘But by failing to engage in the rules now, it may mean your family faces an unexpected bill later. 

‘The good news is there are plenty of things you can do in your lifetime to try to cushion your assets from IHT, so that you can pass on as much of your wealth as possible.’

What can you do?

There are a number of choices available to those who currently have an Isa and want to pass it on to family members.

You can gift up to £3,000 every year free from inheritance tax. It can be gifted however you like, including a Junior Isa if the gift is for your children or grandchildren.

You could also sell the Isa assets and put the proceeds in a trust, but they would no longer qualify for the Isa benefits of tax-free income.

Franks adds: ‘They can be complicated to set up, and similar to making a gift, certain conditions need to be met, including living seven years after placing assets in a trust, for them to be free from IHT on death. ISAs also can’t be held in Trusts.’

Another way to protect your Isa from IHT is by investing in certain Aim-listed shares, however this comes with far bigger risks. 

Certain Aim companies qualify for Business Property Relief (BPR) which means they are exempt from IHT as long as they have been owned for at least two years at the time of death. 

Investors can invest their £20,000 annual Isa allowance, as well as transfer existing Isa pots.

Franks adds: ‘By moving part or all of an Isa portfolio into a BPR-qualifying Aim Isa, you maintain the lifetime benefit of tax-free growth and dividends but can also leave the shares tax free provided you have held it for at least two years when you pass away. 

‘For investors who are happy to take more risk with their wealth, this can save your children and grandchildren a significant unexpected tax bill.

‘However, investors need to be mindful that the tax reliefs are dependent on the investment maintaining its BPR-qualifying status and their portfolio therefore needs to be actively managed, which is why it’s important to seek professional advice if you want to invest in BPR qualifying shares. 

‘Aim IHT portfolios are higher risk than mainstream Isas, and should form part of a balanced portfolio. 

‘Investors also need to recognise that their own individual circumstances and legislation may change in the future, which could affect the tax reliefs.’

Compare the best DIY investing platforms and stocks & shares Isa

Investing online is simple, cheap and can be done from your computer, tablet or phone at a time and place that suits you.

When it comes to choosing a DIY investing platform, stocks & shares Isa or a general investing account, the range of options might seem overwhelming. 

Every provider has a slightly different offering, charging more or less for trading or holding shares and giving access to a different range of stocks, funds and investment trusts. 

When weighing up the right one for you, it’s important to to look at the service that it offers, along with administration charges and dealing fees, plus any other extra costs.

To help you compare investment accounts, we’ve crunched the facts and pulled together a comprehensive guide to choosing the best and cheapest investing account for you. 

We highlight the main players in the table below but would advise doing your own research and considering the points in our full guide linked here.

>> This is Money’s full guide to the best investing platforms and Isas 

DIY INVESTING PLATFORMS AND STOCKS & SHARES ISAS 
Admin charge Charges notes Fund dealing Standard share, trust, ETF dealing Regular investing Dividend reinvestment
AJ Bell YouInvest 0.25%  Max £3.50 per month for shares, trusts, ETFs.  £1.50 £9.95 £1.50 1% (Min £1.50, max £9.95)  More details
Bestinvest 0.40%  Account fee cut to 0.2% for ready made investments Free £4.95 n/a n/a More details
Charles Stanley Direct 0.35%  No platform fee on shares if a trade in that month and annual max of £240 Free £11.50 n/a n/a More details
Fidelity 0.35% on funds £45 fee up to £7,500. Max £45 per year for shares,  trusts,  ETFs Free £10 Free funds £1.50 shares, trusts ETFs £1.50 More details
Hargreaves Lansdown 0.45% Capped at £45 for shares, trusts, ETFs Free £11.95 £1.50 1% (£1 min, £10 max) More details
Interactive Investor  £119.88 as £9.99 per month £7.99 per month back in trading credit £7.99 £7.99 Free £0.99 More details
iWeb £100 one-off £5 £5 n/a 2%, max £5 More details
Freetrade Free for standard account £3 month for Isa  Freetrade Plus with more investments is £9.99/month inc. Isa fee No funds  Free  n/a  n/a  More details 
Vanguard  0.15%   
Only Vanguard funds
Free  Free only Vanguard ETFs  Free  n/a  More details 
(Source: ThisisMoney.co.uk July 2021. Admin charges quoted annually, may be monthly or quarterly)
 

 

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