ISAs and inheritance tax

david4321

The MSE website at moneysavingexpert.com/savings/best-cash-isa, in the FAQ question "What happens to money in a cash ISA if the person has passed away ?" has the following paragraph :
"Currently, upon notification of death, the ISA will be turned into a normal savings account. The money in it loses its tax-free status and will become part of the estate of the deceased. However, from 6 April 2015 this is all changing and a spouse (must be married or civil partnership) will be able to inherit an ISA and retain its tax-free status. This will apply to deaths on or after 3 December. HMRC has confirmed that the ISA will not form part of the deceased persons estate and will therefore not incur any inheritance tax."
I believe the last sentence is wrong. No other website claims this. If your estate is left to your spouse, then there is no inheritance tax anyway. If the estate is left to someone else, then any ISAs are part of the estate for inheritance tax purposes.

masonic

It seems to be confusing two unrelated points. Presumably the change is that the ISA will remain an ISA, where it didn't before.

Consumerist

According to <gov.uk>

Transferring Inheritance Tax thresholds

If someone’s estate is [worth] less than the Inheritance Tax threshold of £325,000, the remaining threshold can be transferred to their husband, wife or civil partner’s estate when they die - even if they remarried.

So it looks as though ISAs left to spouses on death will not count against the transferred threshold when the surviving spouse later dies.

bowlhead99

david4321 wrote: »

"...and a spouse (must be married or civil partnership) will be able to inherit an ISA and retain its tax-free status. This will apply to deaths on or after 3 December. HMRC has confirmed that the ISA will not form part of the deceased persons estate and will therefore not incur any inheritance tax."
I believe the last sentence is wrong. No other website claims this. If your estate is left to your spouse, then there is no inheritance tax anyway. If the estate is left to someone else, then any ISAs are part of the estate for inheritance tax purposes.

The choice of words could perhaps be considered clumsy because it doesn't explain what is going on. Still, it's factually accurate.

It is entirely true that a spouse can inherit both the ISA (the asset) and the ISA wrapper. And it is also entirely true that in the case of such an inheritance the transfer of the ISA to the spouse will not be part of the estate so no there will be no inheritance tax - effectively it just goes from one spouse to the other and is not counted.

Of course, as you point out, you can leave any asset to your spouse and it not be counted for IHT.

So a spouse can already inherit a television and it will retain its status as a television (it does not have to be converted into a different type of item) and will not be counted for IHT.

Effectively the new rules allow you to move ISAs between spouses on death without changing their status and without incurring IHT, just like you can move televisions between spouses on death without changing their status and without incurring IHT. The difference from before, is that is was previously not possible to avoid changing the status.

You are right that if the ISA is left to someone else then it will be part of the inheritance estate and will either be taxed or use up the nil rate band.

Consumerist wrote: »

So it looks as though ISAs left to spouses on death will not count against the transferred threshold when the surviving spouse later dies.

Correct - but of course, nothing (not ISAs, not televisions) left to spouse on death will count against the transferred threshold when the surviving spouse later dies.

Basically when you fill out the IHT402 form to transfer an unused nil rate band, you look at the total size of the nil rate band at the time of the first person's death and see what they gave away on or before death to someone other than spouse and that leaves you with a percentage of the NRB that was unused, and then the spouse that dies secondly can take an extra NRB which is the same percent of the current limit.

Consumerist

Thanks bowlhead.

My understanding is that the ultimate benefit of the change will go to the surviving spouse's beneficiaries e.g. the couple's children, etc.

Do I understand that correctly?

masonic

Consumerist wrote: »

My understanding is that the ultimate benefit of the change will go to the surviving spouse's beneficiaries e.g. the couple's children, etc.

Do I understand that correctly?

If you mean that you think the ISA could pass, for example to the couple's children, complete with ISA wrapper and/or exempt from being counted as part of the surviving spouse's estate, then I don't think that's the case.

Consumerist

masonic wrote: »

If you mean that you think the ISA could pass, for example to the couple's children, complete with ISA wrapper and/or exempt from being counted as part of the surviving spouse's estate, then I don't think that's the case.

You don't say what you do think.

So what advantage do you think the new rules, if enacted, will confer on anyone?

colsten

Consumerist wrote: »

So what advantage do you think the new rules, if enacted, will confer on anyone?

The surviving spouse can now inherit the tax-free investment as a tax-free investment.

Example:
John dies, leaving a £100K ISA. His will passes everything to his wife Martha. Martha can now add John's £100K ISA to her own £150K ISA, i.e. she has a £250K ISA.

Prior to the change of rules, she would have inherited the £100K but in unwrapped form, not as an ISA. Assuming current ISA allowance, it would have taken her 7 tax years to invest the £100K in her ISA.

The ISA wrapper can only be inherited by spouses / civil partners, not by any other heir.

masonic

Consumerist wrote: »

You don't say what you do think.

So what advantage do you think the new rules, if enacted, will confer on anyone?

See my response in post #2. ISAs can transfer between spouses and remain ISAs, that's all that has changed.

bowlhead99

Consumerist wrote: »

T
My understanding is that the ultimate benefit of the change will go to the surviving spouse's beneficiaries e.g. the couple's children, etc.

Do I understand that correctly?

The benefit of the change is that the surviving spouse has a load of assets in a tax protected wrapper where before the change in regulations they would have a load of assets not in a tax protected wrapper. This can only be positive for their wealth and income.

Whether that translates to more money left over for the surviving spouse's eventual beneficiaries depends entirely on whether the surviving spouse spends for themself the additional income or growth that they protect from the taxman.

The IHT rules are not changing so if the ISA value was being inherited by the spouse before the change and the ISA value is still being inherited after the change there is no change to anyone's nil rate bands or the like. All that has changed is that inherited assets that came from a dead person's ISA wrapper can stay in, or go back in, a spouse's ISA.

masonic wrote: »

If you mean that you think the ISA could pass, for example to the couple's children, complete with ISA wrapper and/or exempt from being counted as part of the surviving spouse's estate, then I don't think that's the case.

correct. Children can't get the ISA wrapper for themselves and only spouse to spouse asset transfers are allowed to move outside the taxable estate.

colsten wrote: »

The surviving spouse can now inherit the tax-free investment as a tax-free investment.

Example:

Agreed with that. A clear benefit that will help some people and not hinder others (other than a potential negative effect on HMRC's overall collections over the year). Though of course the ability to keep share-based investments going rather than being forced to cash them out, and the ongoing incentive to be able to use your own allowance to make new investments rather than re-wrapping your dead spouse's old investments, may lead to some small amount of overall net investment in UK companies which can stimulate growth and indirectly lead to greater tax income after all.

So what advantage do you think the new rules, if enacted, will confer on anyone

You say 'if', but there does not seem to be a risk that the new rules will not be enacted as businesses have been informing their clients about it, the government has been giving statements about it, and overall it doesn't cost enough to bother pulling it.

The advantages to a surviving spouse are clear. It is a free tax wrapper. Others who are inheriting fewer assets than they can comfortably fit in their own tax wrapper allowances, will not see much of a benefit.