Can I protect my ISAs from Inheritance Tax?

Q: How do I protect my ISAs from Inheritance Tax (IHT)?

Money held in ISAs does not enjoy any special exemption from Inheritance Tax (IHT) - but that doesn’t mean the tax will be due if you pass on ISA money after death.

Perhaps the most important exemption from IHT is for spouses or civil partners passing wealth to each other - whether ISAs or not. This does not attract IHT, so passing ISAs to a spouse is the simplest way to shield it from the tax.

If you do pass money to a spouse, they will also be able to maintain its ISA status, enjoying tax-free growth and income for themselves as long as the money is held within an ISA. That’s on top of anything they want to contribute to via their own allowance - £20,000 per year. Remember, however, that IHT will potentially become due if they later pass it on at death.

Beyond that, for money passed to beneficiaries other than a spouse, there are sizeable allowances - or ‘nil-rate bands’ - which give you a buffer before IHT is payable. Individuals can usually pass on £325,000 to beneficiaries without IHT applying.

What’s more, spouses and civil partners can pass any unused nil-rate band between them when the first partner dies. The surviving spouse can then pass on as much as £650,000 when they die (assuming the first partner passes on an untouched £325,000 of nil-rate band).

And it doesn’t end there. If the estate includes a primary residence, an extra £175,000 of ‘residence nil-rate band’ is available per individual - as long as the home is being passed to children and the estate overall is worth not more that £2million. If unused, the residence nil-rate band can also be passed between spouses on the death of a first partner.

That takes the total nil-rate band per individual to £500,000. If unused, the residence nil-rate band can also be passed between spouses on the death of a first partner.

Taken altogether, it means a potential £1million of assets could be passed on without IHT applying, assuming this includes a primary residence. That leaves a lot of room to pass your ISAs on without IHT.

Other ways to gift money exist without those gifts being subject to IHT. However, this cannot be done with ISA money while maintaining its tax-free status. You would need to withdraw it from ISAs in your name before the beneficiary then contributes it to an ISA in their name. That reduces what can be sheltered in ISAs to just their allowance.

You can read more about possible ways to gift money without IHT here.

Finally, some investments are potentially exempt from IHT because they qualify for ‘Business Relief’, including some small companies listed on the Alternative Investment Market (AIM) which can also be held in ISAs.

It is important to note that this is suitable only for those with complex finances, involves significant risk and may require professional advice.

Business relief is designed to allow businesses to be passed on without the need for them to be liquidated to settle a tax bill. Most shares listed on public exchanges do not qualify, but some on the AIM market do if held for more than two years. There are strict rules around which companies qualify, and you may not be sure of a company’s eligibility for business relief until it is tested by the tax man after death.

As such, professional advice is recommended before you pursue AIM stocks as a method to reduce your IHT liability.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.