The financial world can be complex, and understanding the implications of ISAs on inheritance tax is crucial for anyone looking to make the most of their savings. Lewis, known for his straightforward and accessible advice, recently addressed these concerns in his BBC podcast. His insights shine a light on a potential pitfall for ISAs that many people may not fully realise, especially those considering passing on their assets to loved ones.
The ISA Allowance and Its Benefits
For many, the appeal of ISAs lies in their simplicity and tax advantages. The annual deposit limit for ISAs currently stands at £20,000, a sum that can be split between different types of ISAs such as cash ISAs and stocks and shares ISAs. Under these conditions, savers can grow their wealth free from income tax or capital gains tax. This makes ISAs particularly valuable for individuals looking to save for long-term goals, such as retirement or buying a home.
However, while ISAs provide tax-free returns during your lifetime, their tax status can change upon your death. According to Martin Lewis, if you pass away and leave your ISA savings to a spouse or civil partner, they are able to inherit your ISA without any immediate tax implications. Not only will they inherit the cash or investments within the ISA, but they will also receive an “additional ISA allowance,” allowing them to continue contributing to their own ISA up to the amount of the deceased’s ISA.
But the situation becomes more complicated when the ISA is inherited by someone other than a spouse or civil partner. In this case, the ISA loses its “ISA status,” meaning the savings or investments inside it are no longer protected from tax. In such cases, the assets could be subject to inheritance tax.
The Hidden Threat: Inheritance Tax on ISAs
The most significant risk associated with ISAs, according to Lewis, is their potential exposure to inheritance tax. While ISAs themselves are not exempt from inheritance tax, their value is included in your estate when calculating how much inheritance tax may be owed. Currently, individuals can pass on up to £325,000 worth of assets tax-free, with an additional allowance of £175,000 available if the assets are passed on to direct descendants, such as children or grandchildren. However, anything above these allowances is subject to inheritance tax, which can be levied at a rate of 40%.
Savers need to be aware that this applies to ISAs as well. For example, if an individual’s estate—ISA included—exceeds the inheritance tax threshold, then the value of the ISA may be taxed at the full 40% rate. According to Lewis, the key point here is that the ISA doesn’t provide any special protection from inheritance tax. This could be especially concerning for high-net-worth individuals with sizeable ISA holdings, as their beneficiaries could face hefty tax bills.
While ISAs remain one of the most tax-efficient ways to save, Martin Lewis’s recent warnings highlight that their benefits do not extend beyond an individual’s lifetime in all cases. Understanding the intricacies of how ISAs are treated for inheritance tax purposes is crucial for anyone planning to pass on their savings.
