Consumer champion Martin Lewis has issued a crucial clarification on the rules surrounding Individual Savings Accounts (ISAs) when the account holder passes away, highlighting both a valuable benefit for spouses and a significant potential tax pitfall.
The Spousal 'Additional Allowance' Benefit
During a recent episode of his BBC podcast, Lewis addressed a listener's query about what happens to ISA savings and allowances upon death. He confirmed a key advantage for married couples and civil partners. When one spouse dies, the surviving partner receives an 'additional ISA allowance' equal to the value of the deceased's ISA.
"The rules are quite interesting. You can effectively leave your ISA allowance to your spouse," Lewis explained, noting that this provision applies specifically to legally married partners or civil partners, not to unmarried cohabiting couples.
He elaborated that, in practice, the assets within the ISA are typically left to the surviving spouse. This process is relatively straightforward, and the inheriting spouse does not face an immediate tax bill on the inherited ISA funds. This allowance is in addition to the survivor's own annual £20,000 ISA subscription limit.
The Stark Inheritance Tax Warning
However, Lewis delivered a critical warning that many ISA holders may overlook. Money held within an ISA forms part of your estate for Inheritance Tax (IHT) purposes. The tax-free wrapper that shields interest, dividends, and capital gains during your lifetime does not protect the capital from IHT upon death.
"It's worth noting that money left in an ISA is still subject to inheritance tax," Lewis stated. "The ISA does not exempt it from inheritance tax, so if you were due to pay inheritance tax, whether it's in or out of an ISA, it still counts as assets for inheritance tax reasons."
This means a sizable ISA pot could be liable for a 40% tax charge if the total value of the estate exceeds available thresholds.
Key Limits and Implications for Other Beneficiaries
Lewis outlined the current IHT framework. Each individual has a £325,000 nil-rate band. An additional £175,000 residence nil-rate band can apply if a main home is passed to direct descendants, such as children or grandchildren. Crucially, any unused allowance can be transferred to a surviving spouse, potentially allowing a couple to shield up to £1 million from IHT.
The expert also highlighted a crucial distinction for beneficiaries other than a spouse. If ISA assets are left to anyone else, such as a child, the ISA's tax-free status is lost. The account is frozen upon death and, after probate, the assets lose their ISA protection. The beneficiary would then be liable for tax on any future income or gains generated by those funds.
This detailed guidance from Martin Lewis underscores the importance of understanding both the valuable spousal benefits and the often-misunderstood inheritance tax implications surrounding ISAs, a cornerstone of UK savings and investment.
