Passing it on
A guide to Isa inheritance
New laws intended to make it easier for grieving relatives to organise their finances are going largely unused, and contain flaws that can leave families with unexpected tax bills. In April 2015, George Osborne, the then chancellor, introduced “inheritable Isas”. The idea was to ensure that money in the tax-free accounts could remain free of tax when transferred to the surviving spouse after death. Previously, they lost their special tax-protected status on death, meaning that the surviving spouse would be liable for tax on any income and capital gains from the Isas from that point.
However, almost nine in 10 savers are failing to take advantage of the new benefits, according to information provided by HM Revenue & Customs following a Freedom of Information request.
Between the implementation of the new laws and July this year, just 39,000 inherited Isa accounts were opened, compared with 387,000 that should have been eligible. HMRC said it did not have all the information on claimants, but the data still points to the majority missing out on the tax break.
What’s more, some who have used the new ability to inherit Isas have met with mixed messages from different banks and building societies, while another flaw in the system means not all Isa money is kept tax-free after death.
How do inherited Isas work?
If your spouse or civil partner were to die, you wouldn’t technically inherit their Isa balance. Instead, you would be entitled to an allowance to the value of their Isa account. This is called an “additional permitted subscription” or APS.
For example, if your spouse had £30,000 saved in an Isa (or several Isas) when they died, you would be able to invest an extra £30,000 tax-free on top of your own £20,000 annual Isa allowance.
The additional allowance can be used once you have registered the death with your partner’s Isa providers. At this point, you have certain options. You could use your APS with your deceased spouse’s bank. However, not all accept them. If your bank does not, it must pass the relevant information to another provider to allow you to transfer the Isa.
You could also transfer the allowance to your own bank or an entirely new provider, as long as they will accept it. Organisations that do accept an APS will have their own rules. Some keep the allowance separate, others allow you to pay the APS into your existing account. Some providers also let customers drip-feed funds into the APS while others may insist on a lump sum.
The flaw being fixed
One problem with the inherited Isa rules is that they don’t allow for any growth in the assets between death and settlement of the estate, landing families with unexpected tax bills.
The glitch means that the value of the Isa for the purposes of determining the additional permitted subscription is taken at the time of death – any growth in the money beyond this is not accounted for.
This is particularly important for stocks and shares Isas, which could grow significantly over the time it takes to settle the estate. Lengthy settlement could exacerbate the problem. Say your spouse leaves a £1m Isa portfolio, which grows at 5pc a year. If the estate takes three years to settle, the value will grow by £160,000. This leaves two problems for beneficiaries, said Sarah Coles of Hargreaves Lansdown, the investment shop.
First, the investment growth will be subject to tax; secondly, the beneficiary will not be able to put all the £160,000 growth into an Isa as it would breach the annual limit of £20,000. The original £1m could go into an Isa using the APS, of course.
However, the Government has announced that it will fix this problem from April next year.
Isas will become a “continuing account of a deceased investor”, or a “continuing Isa” for short. The money will continue to grow tax-free until the estate administration is finalised, the Isa is closed or three years have passed.
The calculation of the APS will also change: it will be the higher of the value of the assets when the estate is closed or the value at death.
A flaw in the system means not all Isa money is kept taxfree after death
‘No provider made it easy’
Margaret Savage, 70, discovered that dealing with inherited Isas was not a simple process after her husband, Alan, died this summer. He had around £145,000 in cash Isas, spread between four banks and building societies.
Ms Savage found that the providers had different rules for processing the inherited Isas and transferring them into her name. In some cases she had to bypass the local branch, which did not have the correct information, and contact the provider’s headquarters to get the right answers.
She said: “It is a tricky area and probably not made use of very often. But while I don’t expect the local branches to have such detail at their fingertips, I do expect that Isa specialists, and possibly even bereavement teams, should be able to inform me of the correct procedure.”