Many ISA savers may not even know these rules exist
Martin Lewis has highlighted some little-known rules around ISAs and when they will attract a tax bill. He explained an important 3-year time limit, after which your ISA holdings could incur a hefty HMRC bill.
He spoke on his BBC podcast about how ISAs work when a person dies. The key benefit of ISAs is any growth within these accounts is entirely tax-free. But when these funds are passed on when you die, the taxman can pounce. Mr Lewis explained how the tax-free status works: “Basically ISAs protect you from the current tax that you have on them. So in a Stocks and Shares ISA, any capital gains—so that’s the gain that you make on a profit, any profits that you make when you sell it—they are not there because it’s sheltered within an ISA wrapper.
“Income tax on dividends is pretty much the same as savings, you know, making interest on savings. So if you’re getting income tax on dividends from your funds or shares within your Shares ISA, again that is protected.” The tax-free benefits you get with your ISAs help protect your other tax allowances.
‘Not taxable’
Mr Lewis said: “Remember ISAs not just aren’t taxed, they’re not taxable, so they don’t count towards your other allowances, your personal allowance, or anything like that aren’t sheltered.” Your personal allowance means you can earn up to £12,570 each tax year without paying tax – but happily any income you derive from your ISA won’t count towards this.
Nonetheless, the taxman may come knocking when the time comes to pass on your worldly goods. Mr Lewis told listeners: “But when you pass an ISA on when you die, it is part of your estate.” As such, it is liable for inheritance tax.
3-year rule
Fortunately, there is a bit of leeway here for your inheritors. The consumer expert said: “Rule number one, the ISA status, when you die, stays tax-free—a continuing account until administration of the estate ends or the third anniversary of death, whichever comes first, but no new money can be paid in. So it stays tax-free.
“When it’s moved on, then it counts towards your inheritance tax allowance that we talked about earlier, £325,000. It would count towards that allowance. It’s part of your estate. So it’s just money that you’ve got.”
Each individual can pass on up to £325,000 in total assets without paying inheritance tax on this, as well as an additional £175,000 allowance. You can pass on any unused allowances to your spouse or civil partner when you die, so they can potentially pass on up to £1million in assets tax-free. Inheritance tax is charged at a standard rate of 40 per cent.
‘Special rule’
There is another important tax-free rule when passing on your ISAs. Married couples and civil partners can benefit from an extra tax perk called the Additional Permitted Subscription (APS).
Mr Lewis told listeners: “There is a special rule for your spouse or civil partner—so your married or civil partner, not cohabiting, not your kids—that they can get an extra ISA allowance of the same as your allowance when you died.” The APS lets the surviving partner claim an additional ISA allowance equal to the value of their partner’s ISAs at the time of their death.
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The financial journalist gave an example of how this applies: “So if you’ve got £50,000 in ISAs, they can get an extra £50,000 tax-free ISA allowance.” Similar to the three-year rule which keeps your ISAs tax-free, the surviving partner gets this extra allowance up to three years from the date of death, or up to 180 days after the estate is settled.
Another perk to note with the APS is your ISA savings themselves can be passed to someone else while the partner keeps the tax allowance. Mr Lewis explained: “And interestingly, I could give my child the money [from the deceased person’s ISAs], but I could still pass the allowance on to my spouse.”
Claiming the allowance
To access this extra allowance, you must contact the bank or building society directly. Mr Lewis said: “They [the surviving partner] can apply for it, but it’s worth noting you have to apply to your ISA provider to get it, and not all ISA providers will allow you to have it.”
If your provider does not offer the APS, you can transfer the ISA to a provider that does.
ISA changes coming soon
While planning ahead for your ISA savings, you may want to note some key rule changes taking effect very soon:
- You can currently pay in up to £20,000 a year into ISAs, and you can divide this as you see fit between the different types of ISAs, across one or more accounts of each type
- From next year, you will only be get a £12,000 allowance you can use however you want. The other £8,000 will only be available for deposits into investment-based ISAs, like stocks and shares ISAs
- People aged 65 and over will retain the current £20,000 allowance. You will qualify for the full £20,000 allowance in the tax year that you reach the age of 65.
