If you are reading this article, you probably already know the basics of ISA management: you can save up to £20,000 per year tax free in a Cash ISA, a Stocks and Shares ISA, a Lifetime ISA, or an Innovative Finance ISA.
But not many people realise that there is a fifth ISA category – the inherited ISA. And the rules are not quite as straightforward as you might think.
What is an inherited ISA?
As the name suggests, an inherited ISA simply refers to any ISA savings which your spouse or civil partner held at the time of their death.
These savings are automatically transferred to the next of kin.
How much can you inherit?
There is no limit on the amount that you can inherit from your spouse’s ISA – if they had £100,000 in savings, then you will inherit £100,000.
The value of your own ISA savings will not affect the amount that you can inherit, and your inherited ISA savings will not impact on your own £20,000 annual tax-free allowance.
Who can inherit an ISA?
Typically, ISA savings are inherited by the surviving spouse or civil partner.
However, in the absence of a partner, these savings will pass to the next of kin.
In the UK, this usually means a close blood relative such as a daughter or son, grandchild, niece or nephew.
If the deceased has specified a non-relative – for instance, in a will or other legal document – then this person is deemed the ‘next of kin’ and will inherit all ISA savings.
Can an ISA be inherited by multiple people?
However, the person who inherits the ISA may choose to distribute it among other members of the family.
Up to £3,000 can be gifted to friends or family members per year, tax free – and if you made no tax-free cash gifts in the previous tax year, you can carry this allowance forward for one year only, bringing your allowance to £6,000.
The new rules for inherited ISAs
It used to be that once an ISA saver died, the benefits of the tax-free wrapper died along with them.
Although the capital investment was safeguarded, any interest or returns built up over the course of their lifetime would be lost.
This meant that the surviving spouse or next of kin had to make some quick decisions regarding their inherited ISA or risk facing a big tax bill.
However, as of 6 April 2018, this is no longer the case. The government has redefined ‘inherited ISAs’ as ‘continuing ISAs’ to help preserve the tax-free savings built up by the original account holder.
However, there are still a few limitations even under these new flexible rules.
No new money can be paid into the ISA from the point of inheritance, but the new ISA owner can continue to benefit from any interest-related growth happening within the tax-free ISA. This continues to be the case either until the administration of the estate is complete, the ISA is closed, or three years have passed since death — whichever is soonest.
At any point, the new ISA account holder can then close down the ISA and use the funds. There are no restrictions on how you can use the funds within an inherited ISA – you can distribute money among your family, donate to charity, pay off some debts, or even re-invest the funds into your own ISA.
Although the annual ISA savings limit is just £20,000, if you have inherited any ISA funds, your annual allowance will be automatically increased to account for the new balance.
So, if you put your full £20,000 into your own ISA account on the first day of the new tax year, then inherited a £100,000 ISA balance the next day; your total annual allowance would become £120,000. This is called the ‘Additional Permitted Subscription’ or ‘APS’.
To further complicate matters, not every bank or building society recognises the APS, and depending on each individual ISA provider’s rules, you might be limited in how much of the inherited ISA you can withdraw or reinvest.
Before taking any action, speak to the ISA provider and find out what limitations are in place with regards to your inherited ISA.