According to the most recent data from HM Revenue & Customs, there are more than 13m Isas currently open.
Investors aged 65 and over hold the lion’s share of Isa assets, each with an average of £34,000 invested across both stocks and shares and cash products.
But while Isas offer valuable benefits during an investor’s lifetime (such as no tax to pay on any income or capital gains made from your Isa investments), many Isa holders will not be aware that ISAs are subject to inheritance tax (IHT) like everything else.
As a reminder, the first £325,000 of an individual’s estate is currently inheritance tax-free, but everything over this threshold will be taxed at 40 per cent. This can be particularly concerning for investors who have accumulated large sums in Isas over the years.
Isa transfers between spouses
Until very recently, spouses lost tax benefits on any Isas left to them by their late husband or wife. However, the December 2014 Autumn Statement gave spouses an additional one-off allowance that would allow them to re-invest up to the amount of ISA their spouse had built up and thereby retain the tax benefits in their own name.
Surviving spouses don’t even need to be left the Isa – they can just make a new investment up to the limit of what their spouse had invested, which is a significant benefit. Spouses are also given the option to change the Isa provider upon transfer, rather than being obliged to continue using the same Isa manager, and holding the previous assets, as the deceased.
Not every estate will benefit from the new rules however, which means that some clients with significant Isa holdings could face a dilemma. On the one hand, they could keep their Isa money invested, continuing to get tax-free growth and income but recognising that IHT would have an effect on the value of their estate when they die.
On the other, they could choose to plan for their estate by reducing the amount liable to inheritance tax; for example, gifting, or cashing out the Isa (and losing the Isa tax benefits) and moving the proceeds into trust. But neither of these options is necessarily going to be a satisfactory one for the investor.
Once a gift has been made, it takes seven years before it falls outside of the client’s taxable estate. In addition, every tax year, clients can make a single lump sum gift of up to £3,000. This gift is known as the ‘annual exemption’.
If the annual exemption isn’t used in one tax year it can be carried over to the next, but the maximum exemption is £6,000. But for those clients likely to leave behind a larger inheritance tax bill, giving away small amounts is likely to have little effect.
Using trusts for estate planning