Can ISAs be protected from IHT?
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
ISAs (individual savings accounts) can be wonderful “vehicles” for savings and investments. Not only are they very tax-efficient, but the Lifetime ISA (LISA) even offers a government “top up” if you use the funds for a first home purchase, or for retirement. However, one of the drawbacks of an ISA is that these are not automatically shielded from inheritance tax (IHT). A pension pot, on the other hand, is not treated as part of your estate for tax purposes when you die – allowing you to pass any unused funds down to beneficiaries, tax-free.
Are there ways to mitigate the impact of IHT on your savings and investments in your ISA? In this article, our team at Castlegate here in Grantham, Lincolnshire offers some ideas to discuss with your financial planner. We hope you find this content helpful. If you want to discuss your own financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
Take advantage of allowances
Remember, in 2021-22 your estate is only liable to IHT if the total value exceeds £325,000 – after which, the typical tax rate is 40%. As such, it is possible to hold a large ISA portfolio (e.g. £200,000) and, provided your other assets do not take you over the threshold, you should not need to pay IHT when you die.
However, many individuals will have a larger estate than £325,000, especially when the value of your home is included. Here, you can take advantage of “main residence nil rate band” (NRB) to pass down an additional £175,000 (in 2021-22), tax-free, to your “direct descendants” provided you bequeath your main home to them. For instance, suppose John wanted to leave his home to his son (worth £400,000) as well as an ISA portfolio worth £50,000. By using the NRB rules, he could pass down all of his estate, IHT-free.
For married couples and civil partners, the power of these allowances can be pushed further to protect your ISA assets. In 2021-22, such couples can pass assets to the other person in the relationship when one person dies, tax-free. If the deceased did not use his/her allowance, then this passes to the other person. For instance, suppose Max dies having not used any of his IHT allowance. This passes to Lydia, his wife, with whom he owned the family home. When she dies, the estate can be passed down to their children using both hers and Max’s allowances. So, if the home is worth £500,000, possessions were valued at £100,000 and £200,000 was held in ISAs, this total (£800,000) could be passed to the children without IHT. This is because Max’s IHT allowance of £325,000 combines with Lydia’s, and his £175,000 NRB combines with hers – meaning they could pass down £1m to direct descendants (including ISAs), IHT-free.
“AIM” ISAs
ISAs can be used to save cash or to invest in assets such as stocks and bonds. Any interest, capital gains or dividends generated within them are tax-free. As mentioned, however, the funds are likely to still be subject to IHT, one day. However, one possibility is to consider investing in “AIM shares” through your ISA. These primarily comprise small, growing companies on the London Stock Exchange. As such, the investment risk involved is usually higher than investing in publicly-listed ones, but the potential returns can also be greater.
From a tax perspective, AIM shares often qualify for Business Relief which allows for 50% or 100% IHT savings. Another option (sitting outside of the ISA structure) is to consider investing in companies which qualify for the Enterprise Investment Scheme. If you hold EIS shares for at least 2 years then these are exempted from the value of your estate for IHT purposes.
Other options
It may be that the aforementioned options may not be viable depending on your financial goals, your investment risk tolerance and the size/nature of your estate. In which case, there are still ideas you can discuss with a financial adviser. One idea, if you have savings in both your ISAs and pensions, is to first draw on funds from the former when you retire. This lets your pension pots (which are exempt from IHT) continue growing – ready for drawdown later.
Another option is to make gifts each year to reduce your IHT liability, later. Remember, every year UK residents can give away up to £3,000 without this being counted as part of your estate (i.e. your “annual exemption”). For instance, you could give up to this amount to your children or grandchildren, to put into their own Junior ISAs. You can also make as many individual £250 gifts as you like, and you can also make tax-free gifts (up to a limit) to people getting married or entering a civil partnership.
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
