Personal Investing
Ed Monk 30 Nov 2017 05:36pm

ISA tweak could boost your inheritance

As much as it might be complained about, tax on investment gains is now only a minor concern for most ordinary investors
Caption: Spouses may benefit from the change
The annual limits on tax-efficient saving are currently set at levels that mean only those with very high sums to set aside need worry. Most can contribute £40,000 a year into a pension, while the rise in the ISA allowance this year to £20,000 means the majority of investors can shelter their gains from the tax man.

As with any complicated set of rules, however, loopholes and anomalies can open up and leave some people exposed. This has been the case in one area of the ISA rules in particular - the gains made on invested ISA money after the ISA holder has died.

It’s commonly understood that ISA money can be inherited by spouses and civil partners tax-free. This is broadly correct, but the way the rules work mean it’s more complicated than simply inheriting the ISA lock, stock and barrel.

Rather, when a person dies, their spouse is allowed extra ISA allowance equivalent to the value of their deceased spouse’s ISA to add to their own limit. This is called an Additional Permitted Subscription allowance.

So, if a person died with £40,000 of ISA assets, their spouse could boost their own allowance by £40,000 (taking it to £60,000 under current limits). If they wish, they can then use this extra allowance to rehouse the money that was previously in their spouse’s ISA, although they don’t have to.

The problem comes because the extra allowance is frozen at the value of the ISA on the date of death. Any gains made after that, and before the spouse takes receipt of the money, falls outside of the ISA wrapper. This is a problem because probate - the process of settling a person’s will, including any tax liabilities - can take months to sort out. Years in the worst cases.

If the investments grow in that time, and the receiving spouse has no spare ISA allowance of their own, they will not be able to house it all within their new, expanded ISA allowance. They also potentially face paying tax on gains made since their spouse passed away.

There’s a financial cost to that, of course, but also it adds extra hassle and bureaucracy at a time when families have other things to worry about.

From 6 April 2018 this is being removed. Changes to ISA rules mean that, with the exception of Junior ISAs – ISAs left behind after death – who will become a ‘continuing ISA’ in which gains continue to be tax free. This situation continues until the probate process is complete, the ISA is closed or three years have passed - whichever is sooner.

The surviving spouse still benefits from an Additional Permitted Subscription in order to rehouse the money if they wish, but this is worked out as being equal to the value of the money passed on, or the value at death, whichever is higher.

Whether or not the Budget this week brings bad news for investors, here at least is a tax change that makes investing simpler and fairer.

Register for a 10% Personal Investing discount with Fidelity

Important information

The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Eligibility to invest into an ISA or Junior ISA and the value of tax savings depends on personal circumstances and all tax rules may change. Junior ISAs are only available to UK resident children under 18 who do not have and are not eligible for a Child Trust Fund (CTF). Please note that if your child was born between 1 September 2002 and 2 January 2011 the Government would have automatically opened a CTF on your behalf so your child will not be eligible for a Junior ISA. The investment is locked away until the child reaches 18 years old. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.