Are IFISAs & ISAs subject to inheritance tax?

Are IFISAs & ISAs subject to inheritance tax?

IFISAs & ISAs are a great financial product if you want to take advantage of paying no tax on the interest you make, up to your yearly limit, but they can also be beneficial when you die too. Please remember you may not get back the full amount you put in. Your capital is at risk if you invest and not protected by the Financial Services Compensation Scheme (FSCS).It’s not a subject anyone wants to talk about, in fact it’s one most people put off, yet planning your finances so they’re set up correctly when you die can save your loved ones a lot of hassle, and money.

Inheritance tax (IHT) is paid by a minority of people in the UK yet for those who do pay it, the costs can be high. In the tax year 2018 to 2019, for example, 3.7% or 22,100 of UK deaths resulted in an IHT charge, according to government data.

But with some careful estate planning, and the use of IFISAs & ISAs, you may be able to reduce your tax bill. Here we look at how it works, and how much you could save.

What is inheritance tax?

In the UK inheritance tax is applied to estates worth over £325,000. That’s the value of everything you own such as money in an Cash ISA or IFISA, stocks and shares, property, and investments.

If someone’s estate is worth more than £325,000, anything above this will be taxed at 40% as inheritance tax.

It is charged for a reason but there are lots of situations where you can pay less tax, and opportunities to legally lower your IHT bill.

For example, since 2015 there is also the ‘residence nil-rate band’ which is worth £175,000 on top of your IHT allowance. It’s allowed if a main residence is passed onto children or grandchildren. 

How can you avoid paying tax with an IFISA or ISA?

IFISAs & ISAs have many advantages. Not only can you save into one without paying any tax, up to the yearly limit of £20,000, there are some benefits for estate planning too.

However, unfortunately when your estate is calculated, IFISAs & ISAs can’t generally be shielded from the tax man, and anything you own in one is usually counted. 

This means if you have £50,000 saved in an ISA, or £70,000 in an IFISA, for example, this money will be included when your estate is being added up. Then anything over the limit will be taxed at 40%. 

Yet if you have a surviving spouse there is an exception to this rule.

Can an IFISA or ISA allowance be transferred to someone else?

If you have a partner - and you’re married or in a civil partnership - it’s possible to transfer your IFISA or ISA to them without paying inheritance tax on it.

This doesn’t apply to any savings not held within an ISA. 

Transferring over an IFISA or ISA to a spouse when you die is known as Additional Permitted Subscription (APS). 

It means they will inherit the money within your ISA but also a new ISA allowance.

For example, if one person had £100,000 in an ISA, this could be transferred to their spouse and they would get an allowance of £120,000 - £100,000 from your ISA and £20,000 of their own annual ISA allowance. 

When an IFISA or ISA is transferred what happens to it? 

The APS rule also applies if money is left to another person, say a child or grandchild, in a will. For example, if £30,000 was left to a child and £70,000 to a surviving spouse, the spouse would still benefit from £100,000 of the additional IFISA allowance. 

When balances are transferred the surviving partner can decide what to do with them. The money could remain where it originally was or they can open a new account.

This all depends on how much money is left, where it’s kept, what the financial situation is of the partner, and what their savings goals are.

If, for example, a husband has a £50,000 additional IFISA allowance left from his wife who has died, he could keep this in the IFISA it’s in or if he finds one offering a better return, he might open a new account for it.

Before making this decision it’s worth checking with an ISA or IFISA provider, as not all of them will accept these additional allowances automatically. 

There is also a three-year time limit, after the date of the death, to claim the additional allowance.  

Can you transfer an ISA allowance if someone is still alive?

The additional IFISA or ISA rule only applies when you die, transferring an ISA to a husband or wife, or civil partner, while you’re alive is likely to cost you money rather than saving you any.

Your option here is to withdraw the money or investments from within an ISA, which takes them out of their tax-efficient wrapper. When they are reinvested by your partner, they then only have their £20,000 annual allowance. 

There is an option of doing this every year until an ISA allowance has been moved between two people but there are usually costs for selling investments and for closing a stocks and shares ISA. Any period of time when money isn’t in an ISA or invested will usually see its value reduced as well. 

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All the facts and figures presented are accurate at the time of posting.

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