Inheritance tax and ISAs
What happens to my ISA when I die?
Many don’t realise the tax treatment of ISAs – so favourable whilst you live – can be anything but when you die.
The general rule is that ISA savings can be passed on to any beneficiaries named in your will or, if you don’t have a will, through the laws of intestacy.
The tax implications of this could, however, be significant.
ISAs lose their tax-efficient status on death. This means the beneficiary will not benefit from tax-free income and growth and might have to declare them in their tax return.
In addition, ISAs can form part of your estate. If your estate is liable for inheritance tax, your ISA will be caught too.
There are, however, two exceptions.
1. If you have a spouse or civil partner
Since April 2015 it is possible to effectively pass on your ISA to a surviving spouse or civil partner without them losing the benefit of tax-free income and growth.
In practice, on your death, your surviving spouse or civil partner will receive a one-off ISA allowance equal to the total value of you ISAs. This is called the Additional Permitted Subscription (APS) allowance and is in addition to, and independent of, your spouse’s or civil partner’s annual ISA allowance.
They can use the APS to make an ISA subscription with the same manager who held your ISA or another manager who agrees to accept the subscription.
Your spouse or partner should, therefore, be able to continue benefitting from tax-free income and growth whilst the funds remain in the ISA.
On their death, the ISA will form part of their estate and potentially be subject to inheritance tax.
In other words, whilst the tax benefits on income and growth are preserved, the IHT problem is postponed rather than solved.
2. If you invest in certain AIM stocks through your ISA
Since August 2013 it is effectively possible to pass on an ISA to any beneficiary of your choice free of IHT.
This is because new rules were introduced to allow you to hold AIM shares in a Stocks & Shares ISA.
Many companies listed on AIM can qualify for something called Business Property Relief, BPR in short. If your ISA is invested in BPR-qualifying AIM stocks you should be able to pass it on to your loved ones without them paying a penny in IHT. That’s provided you hold the shares for at least two years and still hold them on your death.
Just to clarify: BPR has been around for years and investors have been taking advantage of it for over a decade. What is relatively new is the ability to combine the IHT relief granted by BPR with the ISA tax benefits of tax-free income and growth.
It’s only since August 2013 that new rules have allowed AIM shares to be held in an ISA, thereby making the IHT-free ISA a reality. So you could enjoy tax-free growth and income during your life with the peace of mind no inheritance tax should be due on your death.
AIM shares are for experienced investors and should be considered only as part of a wider portfolio. They are more volatile, less liquid and generally seen as higher risk than more mainstream investments: you could get back less than you invest.
Can I put my ISA in trust?
ISAs are individual savings accounts, so can only be held by an individual, not by a legal entity such as trust.
You could, however, sell the ISA assets and put the proceeds in trust. Once in trust, they would no longer qualify for the ISA benefits of tax-free income and growth but could become completely IHT free, usually seven years after the trust has been established.
Once in a trust, the assets cannot normally be accessed.
How could I protect my ISA from IHT?
One way investors could continue receiving the ISA benefits whilst they live and protect the assets from IHT when they die is to invest in certain AIM shares.
Shares in companies that qualify for BPR can normally be passed on free of IHT after two years, provided they’re still held on death and the company still qualifies for the relief.
What is BPR?
BPR was first introduced in 1976 to allow family businesses to be passed down through generations free of IHT.
Its scope subsequently widened and since 1996 it was made available for a range of assets, including limited companies.
This means if you buy and holds shares in such companies you could potentially pass on those shares IHT free provided that:
- the shares are held for at least two years and are still held on death
- the company still qualifies for BPR at the time of the investor’s death
You could buy as few or as many shares as you wish. There is no upper limit or allowance. Provided the above conditions are met, the whole value of the investment – be it £10,000 or £10 million – should attract 100% IHT relief.
Please note, tax benefits depend on circumstances and tax rules can change.
Which AIM shares could qualify for BPR?
HMRC has set rules to determine the type of company that could qualify for BPR.
The main requirements are that the company must be trading and must not be listed on a main stock exchange either in the UK or abroad.
The most notable exclusions are companies that mainly deal with investments, land or buildings and not-for-profit organisations.
However, HMRC does not provide a list of qualifying companies. Instead, it assesses the company retrospectively: when a claim for relief is made (during the probate process) HMRC will confirm if the companies of which the deceased was a shareholder qualifies for BPR and whether the shares can consequently be passed on free of IHT.
Importantly, to benefit from 100% relief, the company must qualify for BPR at the time of the investment and remain qualifying until the relief is claimed.
How could I pick AIM shares that qualify for BPR?
One option is to research the shares yourself to establish their investment merit and BPR-qualifying status. AIM-listed companies, when contacted, should be able to confirm if they think they qualify for BPR at that point. You should check this regularly as a company that qualifies today may not qualify in future.
An increasingly popular alternative is to invest in an AIM ISA portfolio, a ready-made portfolio of BPR-qualifying shares managed by a professional manager.
IHT planning can be complex: if you are not sure please seek advice. Tax rules change and tax benefits depend on circumstances.
Do AIM VCTs also qualify for IHT relief?
AIM Venture Capital Trusts do not now qualify for IHT relief, even though their underlying holdings might. This is because when you invest in a VCT, you acquire shares in the trust (the VCT company), not in its underlying holdings. Only when you invest directly in a company that qualifies for BPR could your investment be IHT free.