When it comes to understanding the tax rules around ISAs it’s usually around your own annual ISA allowance.
These tax rules are generally straightforward, with your tax-free annual allowance staying at £20,000 – but what about if you inherit an ISA? Or even, indeed, if you can inherit an ISA?
This article covers what should happen if your spouse or civil partner died and you come into possession of their ISA.
Important information - investment value can go up or down and you could get back less than you invest. If you're in any doubt about the suitability of a Stocks & Shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.
Inherited ISA allowance
If the worst happens – and your spouse or civil partner passes away, then one of the hardest things to deal with is the financial side of things – on top of the accompanying emotions. This can add more upset and frustration to an already difficult time.
However, if this happens, you should be able to inherit their ISA savings via an ‘Inherited ISA Allowance’, which is also referred to as an APS – ‘Additional Permitted Subscription‘.
This means that the surviving partner will be given a one-off additional ISA allowance that is the same as the ISA allowance of the deceased partner at their time of death.
So, for example, if someone’s civil partner or spouse dies, and leaves them an ISA with the value of £40,000, then the partner inheriting will have their £20,000 ISA allowance – as is available to all savers in that tax year, but they will also get an additional allowance or APS of £40,000 as a result of the inheritance of their partner’s ISA.
This is a relatively new rule, having only been put into place in April 2015. Before this, although the ISA savings would be passed on to any beneficiary that has been named in the will, they will automatically be removed from the income-tax-free zone that they previously enjoyed. As such, if you dies, and your partner was looking to reinvest the savings you had accrued from your ISA funds, they would only be able to do this up to their remaining ISA allowance in that tax year
How does an inherited ISA work?
It doesn’t matter what the deceased partner states in their last will and testament, this additional ISA allowance can be used regardless. As such, if the deceased chooses to leave the money to another individual – any person other than the spouse, the partner is still entitled to an increased ISA allowance that would be the monetary equivalent of the ISA funds.
For example, if a person was to leave £40,000 worth of ISA funds to their child, their partner would still be allowed an increased ISA allowance up to that £40,000 value. However, they would need to use £40,000 of their own money if they wanted to make use of it.
ISA growth post death
As of April 6th 2018, all ISAs – apart from the Junior ISA has been re-established as a continuing ISA – or a Continuing Account of a Deceased Investor. This means that any growth in value that the ISA experiences after the death of the holder is still tax-free.
So, if there is any sort of delay – and the deceased spouse’s ISA can’t be transferred over for a few months – and in that time, there is an additional £200 in interest accrued, the living partner will not lose out on the extra money as it will make up the APS.
Again, this hasn’t always been the case. It used to be the case that the increase in allowance was frozen at the value of the ISA when the person passed away. As such – this meant that any additional interest earned after the person had died would start becoming taxable as soon as the probate process began – which, in some instances might be months or even years if things are particularly complex.
This change in ruling means that the APS allowance is equal to the same amount of money that the inheritor receives – or the value at the time of death depending on whichever is greatest.
Do ISA subscriptions have a time limit?
Because it can take a lot of time to sort out the affairs of someone who has deceased, the increased ISA allowance can be claimed simply by filling out a fairly straightforward application form – for up to three years after death or, 180 days after the administration of the estate if this is longer.
Again, these are reasonably new, and have only come into force in April 2018. These rules mean that during the deceased person’s ISA administration, no money can be paid in. However, it will still benefit from enjoying a tax-free status along with tax-free growth.
This is known as ‘continuing ISA’ and it goes on until either the ISA is closed, the administration of the estate has been finalised or three years after the person passed away – whichever one of these happens first.
Investing inherited ISAs
The partner who inherits the deceased person’s ISA can then decide where they wish to transfer these inherited savings. They have a few options.
Firstly, they could choose to keep that money with its original ISA provider. They also have the option of transferring the money into their own current ISA provider. Another option is to open up a brand new ISA – either a cash ISA or an investment stocks and shares ISA and place their additional subscription in there.
However, you need to remember that you can only transfer an APS just one time. If there is more than one ISA inherited, then you will get that additional allowance with all of the ISA providers.
Furthermore, current ISA rules state that an investor is only allowed on stocks and shares is a plus one cash ISA per tax year. However, if you open up a new, additional ISA with the purpose of simply transferring inherited ISA funds, then this would not be in breach of these rules.
This means that you are allowed to have your own cash ISA with your personal bank and open up a cash ISA in a new bank for your inherited ISA savings. As soon as you have transferred your inherited ISA funds, the standard rules of ISAs will apply, but the money will be treated as though it was the previous year’s savings.
Do all ISA providers accept APS payments?
No – in theory, no ISA provider is legally obliged to accept an APS allowance, which means that your chosen provider might not accept your inherited ISA savings. In fact, in the last survey completed, it was determined that 45% of the fixed and variable rate ISAs available on the current marketplace will accept APS ISA transfers.
There have, however, been a handful of providers that have created special products that take advantage of these new rules, which are worth looking at if you find yourself in this situation. However, there are some that will only accept the APS payments if the original ISA holder (the deceased partner) was already a customer of theirs.
Both cash ISAs and stocks and shares ISAs are treated the same way under the current rules and regulations. This means that the surviving partner is allowed to make additional subscriptions into stocks and shares ISAs or cash ISAs.
There are a couple of ways that the surviving spouse can use the stocks and shares additional allowance. Firstly, they could choose to sell the investments for cash. The stocks and shares could be sold with the cash earned being used to open a new ISA – which is known as a cash transfer. Another option is to transfer the investments as is. They don’t need to be sold in order to be transferred. This type of transfer is called an ‘in specie’ transfer.
An APS made using an ‘in specie’ transfer has a deadline of 180 days from the surviving spouse or civil partner inheriting the assets. They can also only be made to the provider of the deceased ISA.
Inheriting an ISA FAQs
Here are some of the most frequently asked questions regarding the inheritance of ISAs
Can children inherit ISAs?
Yes. Just like any other investment, a child is able to inherit an ISA – however, this won’t be treated the same way as a partner inheriting the ISA – i.e. it won’t be inherited in the tax-free way that a spouse or partner would. Instead, the funds from the ISA would be considered as a part of the estate of the deceased person. This means that, like the rest of the estate, it will be likely that you will need to pay inheritance tax on it. Moreover, the ISA allowance will still go to the partner or spouse of the deceased, even if the ISA money doesn’t.
Are ISAs exempt from inheritance tax?
No, although a partner will enjoy tax benefits from the current ISA tax rules, ISA inheritance rules don’t mean that they are completely exempt from inheritance tax. Under current rules, they form a part of a person’s taxable estate along with their other property, possessions and savings.
However, if the deceased person’s estate is less than £325,000, which is the nil-rate band (it may be more if it contains a property that was the deceased party’s primary residence), then none of it will be subject to inheritance tax).
Can I inherit a Junior ISA?
A junior ISA works in the way that it is held only until the child holding the ISA reaches their 18th birthday. They can then choose to do whatever they like with these monies. However, if the unthinkable happens, and the child passes before they reach this age, then the investments made in the Junior ISA will go to the person that inherits their estate. Normally this would be the parents, and as such, wouldn’t be subject to the tax-free inheritance ISA allowance rules. If they happen to be over sixteen and married, then it would be treated the same way as standard ISA inheritance tax rules.
Can Lifetime ISAs be inherited?
Yes, the rules around a lifetime ISA are exactly the same as the rules around any other type of ISA. The government bonuses would have been paid into the deceased partner’s account monthly when the person was still living and these will be passed on to whoever inherits it. It works in the same way as others, in so much as only a spouse or civil partner will benefit from the tax-free ISA allowance transfer.
Can ISA be inherited tax-free?
No, although a partner can enjoy tax-free ISA allowance transfer, the ISA is still part of the estate and subject to inheritance band if their estate is over £325,000.