Techzone

Recent HMRC figures show that there was £518 billion in adult ISAs as of April 2016, with more than half of this held by the over 65s. That represents a huge amount of wealth which will be changing hands over the coming years.

The tax benefits of ISAs are generally well known and easily understood. However, understanding of their treatment on death is less so. The ISA inheritability rules are complex but valuable, as they can ensure that a couple’s savings continue to be protected from income and capital gains tax for their joint lifetime.

But there's no protection from IHT and that could see 40% wiped off the value that's passed to the next generation. It's therefore important to consider how these savings and other wealth can be used in retirement, while maximising the benefits for the next generation.

ISA inheritability

It's now possible for a surviving spouse or civil partner to continue to enjoy the same tax free investment returns as their deceased spouse on their ISA funds.

The surviving spouse doesn’t automatically inherit their spouses ISA - this is subject to the normal rules on the distribution of the estate, i.e. whatever is in the Will or under the laws of intestacy. Obviously, any ISA savings passed to a surviving spouse will be exempt from IHT under the spouse exemption, while funds paid to children will use up some of the deceased's nil rate band and, if large enough, could result in an IHT charge.

But in the majority of family situations it's likely that ISA savings will be passed to the surviving spouse. Irrespective of who the funds are actually left to, the surviving spouse can still apply for an Additional Permitted Subscription (APS). This gives them an increased ISA allowance equal to their deceased spouse’s ISA funds at the date of death and they can satisfy this subscription from savings of their own.

How the APS works

A surviving spouse has a choice where they register the APS. This could be with:

• the deceased spouse’s ISA Manager; or
• with an ISA manager of your own choice.

It doesn’t have to match the ISA type held by the deceased - so an APS from a deceased’s cash ISA can be applied to Stock and Shares ISA in the survivor’s name.

If the deceased held separate ISA accounts with the same ISA provider, then the date of death values would be combined to give one aggregate APS.

It's possible to have multiple APS’s with different ISA providers, in which case there will be an APS for each separate ISA.

But once the APS has registered to an ISA, it's only that ISA which can accept the increased subscriptions. Any unused balance cannot be paid to another ISA.

Once the ISA subscriptions have been used, the normal ISA transfer rules still apply and ISAs can be moved to another provider. But any amount of unused APS would be lost on transfer.

Things to consider when registering the APS

It's important to consider where ultimately you would like the funds to end up when registering the APS. Having everything under one umbrella can reduce administration and make future planning and asset allocation decisions easier to manage.

The simplest solution may often be to register it with deceased’s ISA provider. This may allow the possibility of satisfying the ISA subscription using the non-cash assets held at the date of death (such as shares or unit trusts) without having to sell them. ‘In specie’ subscriptions must be made within 180 days of the assets spouse owning the assets. And the surviving spouse can always transfer to another ISA provider at a later date.

If the surviving spouse has insufficient funds to pay the APS in its entirety, they can spread the APS over a three year period starting from the date of death. This might be useful if they don't have enough liquid assets to pay in up front, or if market conditions are not beneficial to the sale of equity based investments.

A surviving spouse may wish to choose their own ISA provider if they have the cash to maximise their APS. Paying to just one ISA manager and keeping everything under one roof can have huge benefits in terms of administration and monitoring.

Of course, death doesn’t have to act as the trigger to consolidate ISA funds. Consolidation during lifetime offers all the same advantages and would make the administration of the estate easier for executors too.

Tax Issues

There is currently no continued protection from income and gains once the ISA wrapper falls away on death. But there are plans in the pipeline to correct this.

As it currently stands if the assets have grown in value since the date of death there could be some CGT to pay. And it also may require some of the current year’s subscription limit to allow the whole fund to be paid into ISAs.

The intention is that eventually, once new legislation is introduced, income and gains during the administration of the estate will be exempt and the APS value will be taken from the date Probate is granted. 

The IHT trap

The purpose of the APS is to maintain the income tax and CGT benefits for the surviving spouse. But while the ISA may escape IHT on first death thanks to the spousal exemption, it will eventually be caught in the IHT net on the second death.

Clients who are beyond age 55 and who also have a modern flexi access pension may wish to think carefully about how they fund retirement, particularly if maximising their children’s inheritance is a priority. This is simply because most pensions will be free from IHT and, similar to ISAs, income and gains from investments will be free from tax. And if the client dies before age 75, their beneficiaries can also access the funds tax free at any time.

It's easy to see how drawing on their ISA and leaving their pension untouched could see a big saving in IHT for some clients.

Of course, there may be other things that can influence a decision, such as the potential for a Lifetime Allowance charge on larger pension funds, or significant spending plans. Clients need to think holistically about their futures.  

There is also a strong case for moving ISA funds into pension where there are sufficient allowances to allow it. With contributions enjoying tax relief at their highest marginal rate, it will generally provide a greater like for like for return than an ISA even after paying income tax when benefits are drawn. This exercise is best done prior to retirement while clients are still earning and have greater potential to pay more into their pension.

Summary

With the allowance now set at £20,000 a year, your clients may holding a significant proportion of their wealth in their ISA. The ISA millionaire is no longer a pipedream but a reality. This means the significance of ISAs in estate planning has taken on greater importance and advisers need to be clear on the options available.