What will happen to my ISA when I die?

For a product that looks pretty simple on the surface, individual savings account (ISA) rules can sometimes be quite confusing, and no more so when somebody passes away.

That means when you are thinking about your estate planning, it makes sense to give some thought to what will happen to any ISAs that you have. Similarly, if you ever find yourself taking care of someone’s estate once they’ve died, it’s helpful to understand what happens to these particular assets.

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From inheritance tax (IHT) to increased allowances, we explain everything you need to know.

When you die…

The first thing to know is that your ISA won’t be closed as soon as you die. However, it’s status will change.

Once your ISA provider has been notified of your death, it will be converted into a “continuing ISA”. A not-very-helpful bit of financial services jargon, this essentially means that no further contributions can be made to the account, although your money can continue to grow and will remain tax free.

This status will remain in force until either the administration of your estate is complete or the account is formally closed by your executor. If neither of these things happen within three years and a day, your ISA provider will finally close the account.

Passing on your ISA

You can’t pass on an ISA account per se; however, you can leave the money in it to whoever you like.

What happens next will depend on who you leave it to and their relationship with you.

If you are married and decide to leave the money to your spouse or civil partner, it will be possible for them to transfer the cash or investments into an ISA of their own.

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Alternatively, if you want to leave your ISA money to somebody you aren’t married to, any investments will be sold and the cash will be paid into your estate and distributed according to the instructions in your will.

The key is that you leave instructions in your will, stating who you want to benefit from your wealth.

What about tax?

This is where it starts to get a bit confusing.

Your spouse or civil partner can effectively inherit your ISA without losing any of the tax breaks – that’s thanks to something called the “Additional Permitted Subscription”.

This is a one-off additional allowance granted to them, on top of their regular £20,000 annual ISA allowance.

The value of the APS will be equivalent to the value of the ISA on the date of death, unless the pot increased in value in the period between death and the final closure of the account, in which case it would be for the higher amount.

This means the full value of your ISA will continue to be sheltered from tax on income and gains after you have died.

However, your spouse or civil partner can still get the benefit of the APS, even if you didn’t leave your ISA money to them. This could be helpful if they have other funds held outside a tax wrapper, such as an ISA or a pension, that would benefit from the shelter.

The APS can be used for any type of ISA - except Junior ISAs - and your spouse will have three years after the date of death (or 180 days after the closure of the estate) to complete it. The time limit also drops to 180 days if you want to make an “in specie” transfer – this is where your investments are moved straight over to the new account, without the need to be sold and converted to cash.

Will my ISA be subject to inheritance tax?

We often talk about ISAs being tax free. But while ISAs will be sheltered from income tax, dividend tax and capital gains tax (CGT), they will form part of your estate when you die. That means they could potentially be subject to inheritance tax (IHT), depending on whether the total value of your estate exceeds your nil rate band (£325,000).

The one exception is any ISA monies invested in qualifying AIM shares that have been held for at least two years, which are IHT exempt under business relief.

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Any transfer to your spouse will be free of IHT, however. You can pass on as much as you like to them tax-free – although IHT could still be payable on their estate when they eventually die, if they don’t get round to spending that money in their lifetime.

That means, it’s worth thinking carefully about who gets your ISA money and, if you want to reduce a future IHT bill, it’s worth getting professional advice.

When you don’t pass your ISA money on to a spouse

If you decide to pass your ISA money on to children, grandchildren, or anyone you aren’t married to. It won’t come in ISA form; your ISA will have been closed, the investments sold and they will just be given the cash to spend as they choose.

But even though it will no longer fall under the tax shelter offered by an ISA, your beneficiaries may be able to get it back if they don’t have an immediate need for the money and want to carry on saving or investing it.

If they haven’t invested £20,000 in an ISA year, for example, they could pay some or all of the money (depending on the size of their inheritance), into a new ISA of their own.

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Or, if they would rather top up their retirement pot, they could pay it into their pension. Each year they can pay in 100% of their annual income (up to £60,000). Although any income taken out of a pension in later life is taxable, they will get the benefit of tax relief on their contribution, equivalent to the rate of interest tax that they pay.

Even if they’ve used up their ISA or pension allowance, they could still “park” money in a general investment account and take steps to shelter it in the future. This can be achieved by selling up investments gradually and moving wealth into either an ISA or pension as allowances become available in upcoming tax years, using a process referred to as “Bed & ISA”.

They just need to be mindful that the amount they sell from their general investment account doesn’t trigger a CGT bill (you can currently only enjoy £3,000 of CGT free each year).