One of the drawbacks of ISAs has always been that they are personal products. Unlike most other investments, Individual Savings Accounts can only be held in a single name (not joint), cannot be assigned, nor can they be placed in trust.
Once inheritability/transfer to a surviving spouse/civil partner was introduced from 3 December 2014, in theory, the ISA could almost be regarded as a joint asset, albeit as a succession of single ownerships.
In practice, it took nearly three and a half years for the legislative reality to catch up with what sounded a simple concept. The first set of ISA inheritance regulations were an administrative nightmare. The second, corrective set then had an elephantine gestation period, and eventually came into force for deaths occurring on or after 6 April 2018.
The rules are now relatively straightforward:
From the date of death, the deceased’s ISA investments remains free of UK income tax and capital gains tax as a ‘continuing account’ until the earlier of:
- the completion of the administration of the deceased's estate;
- the day falling on the third anniversary of the death; or
- the closure of the account and withdrawal of all investments.
A surviving spouse or civil partner can make an additional permitted subscription (APS), in cash or in specie, equal to the greater of:
- the value if the deceased's ISA at the date of death; and
- the value of the ISA immediately before the APS is made.
For an in-specie APS (which can only be made to an ISA managed by the deceased’s account manager), the subscription must be made within 180 days of assets being transferred to the survivor. For a cash APS, the subscription must be paid no later than:
- Three years of the date of death; and
- 180 days after administration is completed.
Small take up
According to the Autumn Statement 2014, around 150,000 married ISA holders die each year. A Freedom of Information request made in late 2018 by Zurich revealed that in 2017/18 (before the latest rule changes) only 21,000 people used the APS facility – about 14% of those potentially eligible.
There are a variety of possible reasons behind the poor take up:
Ignorance could be to blame, especially when DIY estate administration is chosen. This is more likely on the first death of a married couple or civil partners as normally only a simplified IHT form (IHT 205) is required. It does not help that website information, even from the clearing banks, may be out of date.
There is no legislative obligation on ISA providers to accept an APS, so some refuse to do so even if they hold the deceased's ISA, leaving the survivor with no option other than to invest the APS with another provider, adding complexity.
Sometimes executors choose to close all the deceased’s accounts without first considering the consequences of their actions. It is not unknown for some banks and building societies to do the same.
Executors may be unaware that even if cash is ultimately required, the longer that assets remain in the continuing ISA, the better from a tax viewpoint. For example, executors do not have a dividend allowance, so are liable to 7.5% tax on all dividend income during the administration period.
Where cash ISAs are involved, better gross (or even net) returns may be available outside of the ISA wrapper.
With investments held in an ISA potentially having roots that go back to 1987 and PEPs, the size of an APS and future tax savings available can be substantial. In theory, since 1987, up to £326,760 could have been subscribed to PEPs, TESSAs and ISAs.
Come the ISA season, the press regularly has no difficulty in discovering ISA millionaires, so theoretically, the ISA inheritor could become an ISA multi-millionaire.
Instead of a pension...
Even at much more modest levels, ISAs can act as an alternative to pensions for income in retirement. Under the current IHT rules, drawing nothing from a pension to maximise its value (outside the estate) while running down the value of an ISA (within the estate) is the logical approach to providing retirement income. Using the ISA means that any withdrawals are tax-free, whereas pension withdrawals could attract full income tax.
There is nothing to prevent the APS arising from a cash ISA being invested in a stocks and shares ISA or a similar post-APS transfer being made. Such a move can be a way to boost income – at the time of writing the yield on the FTSE 100 was around 4.5%, well above fixed rate cash ISA interest rates. The opposite – a stocks and shares to cash switch – is also available and could be relevant if an early encashment is anticipated.
Quick case study: ISA, not pension...
Jack died at age 78, leaving his widow, Joan, with an ISA worth £300,000 and a SIPP also valued at £300,000. Joan needs an income of £16,000 a year net from these, in addition to her own pension and other investment income. Looking at the binary choice of using either the ISA or the pension to provide this:
- The pension income would be taxable given Jack’s age at death, which means Joan would need to draw £20,000 a year gross.
- Any withdrawals from an APS-created ISA would be tax free.
Assuming a return after charges of 4% a year and that at the margin all of the ISA remaining would attract IHT, if Joan dies 10 years after Jack, the two options produce the following results:
| ||ISA value ||Pension value |
| Gross || 251,975 || 444,073 |
| IHT || 100,790 || |
| Net || 151,185 || 444,073 |
| ||ISA value ||Pension value |
| Gross || 444,073 ||203,951 |
| IHT || 177,629 || |
| Net || 266,444 ||203,951 |
As the pension value will potentially be taxable if taken as a lump sum after age 75, the two numbers cannot simply be added for comparison purposes. However, even if the entire pension pot were taxed at 45%, the ISA draw route would still produce a net £16,800 extra for Joan’s beneficiaries.
APS is just the start
Making an APS is not the end of planning with inherited ISAs – it may be just the start.
For example, the simplest initial option might be to place the APS with the deceased’s ISA provider. Subsequently the survivor could consolidate that ISA with their own ISA funds in a new ISA, better suited to their new circumstances.
That could be a flexible ISA, giving the survivor the opportunity to drain out funds in cash and then replenish before the end of the tax year. Some investment platforms offer the flexible ISA functionality with stocks & shares ISAs, which could enable significantly more tax-free income to be taken each year.
'But I don’t need the money…'
If the survivor does not require the ISA capital, it may be wise from an estate planning viewpoint to redirect the ISA’s value to children (or generation-skip to grandchildren), either via a deed of variation or as a lifetime gift from the survivor. The latter is preferable if there is a reasonable chance of outlasting the inter-vivos period of seven years (or possibly five, under the OTS simplification proposals).
A gift of the deceased’s ISA value does not prevent the survivor making an APS as there are no restrictions on the source of APS funds, a point not widely appreciated. The survivor could use their own cash and investments to cover the APS, effectively sheltering an existing portfolio.
Time to rise above 14%
As this article demonstrates, inheritability has extended the potential use of ISAs in financial planning. What started life as a simple tax-efficient personal savings plan now has a role in retirement provision and estate planning.
Andy Woollon is retail specialist at Zurich UK