Following the pension freedoms, the changes to the taxation of pension death benefits have brought questions about the legitimacy of conventional decumulation and estate planning strategies. But the Isa also has some inheritable tax perks up its sleeve, and these are set to improve further.
The focus of Isa tax benefits tends to be on the income tax and capital gains tax (CGT) advantages. From a death taxes perspective, the inheritance tax (IHT) treatment of an Isa depends on the investments held within it and to whom the proceeds are paid – assets passed to a spouse or registered civil partner, or to a registered charity or political party are free from IHT. All other transfers are potentially subject to IHT, depending on the size of the estate.
Business property relief
The majority of assets held within Isas are subject to IHT. Since August 2013, Aim shares have been a qualifying investment for Isa wrappers. Certain Aim shares qualify for the business property relief (BPR) IHT exemption provided they are held for two years or more. The holding period starts from the date of original acquisition so Aim shares can be moved into an Isa via bed & Isa without restarting the two-year clock.
While this provides the potential for an entirely tax-free investment both during lifetime and on death, in reality it is not all plain sailing.
Generally speaking, BPR is not available where the business mainly deals in land or buildings or the making or holding of investments. It is also important to note that the qualification status for BPR is assessed at the date of death and may have changed since the date of investment.
Since 6 April 2015, the value of accumulated Isas can be paid into an Isa of a surviving spouse or civil partner with no upper limit and without affecting their own Isa allowance. This applies to deaths on or after 3 December 2014. This provides a much-needed tax break for married couples who typically manage their family money together.
The current system is a little clunky, but this was to ensure it could be implemented in a short period of time. This tax break is offered using an additional permitted subscription (APS).
Isa tax status on death
To understand the reasoning behind the APS it is important to understand that the tax-free status of an Isa is currently lost at the date of death. From that date, the cash and investments held become taxable in the hands of the personal representatives until probate and distribution.
This means that surviving spouses receive taxable assets outside an Isa wrapper and are therefore subject to taxes they would not have needed to consider while their spouse or partner held the Isa.
The simple solution would appear to have been to just retain the Isa status from the date of death. However, there was insufficient time to bring in the secondary legislation required prior to the beginning of the 2015/2016 tax year. Further to this, in the 2015 Autumn Statement, chancellor George Osborne announced that the Isa status would be maintained for Isa investments during the estate administration period. This change is expected to take effect from 6 April 2016 after a technical consultation with Isa providers.