An ISA is a type of savings account where any interest you earn is always protected from tax.
If you’re a 20% basic-rate taxpayer, you can earn £1,000 in savings interest every tax year before you pay tax. For 40% higher rate taxpayers, the amount is smaller at £500, while 45% additional rate taxpayers cannot earn any tax-free interest on savings.
It’s estimated over 2.7million individuals will pay tax on interest in the 2023/24 tax year, due to a combination of better savings rates, following Bank of England interest rate hikes, and frozen tax thresholds. But what happens to your ISA savings when you pass away, and are they subject to Inheritance Tax?
Sarah Coles, head of personal finance at Hargreaves Lansdown, explained that when you pass away, any money you have saved in an ISAs in your name will form part of your estate, so will be included when your estate is valued for Inheritance Tax purposes.
But there are some ways you can leave savings to your loved ones completely legally. Sarah told the Mirror: "If you want to leave savings or investments to family members, it can make sense to make gifts during your lifetime. If they are under the age of 18, it can make an awful lot of sense to pay into a Junior ISA for them.
"Each year you can give up to £3,000 within your annual allowance. You can also make regular gifts from your income, and as long as it doesn’t leave you short, it counts as being from your ‘surplus’ income, and is out of your estate immediately for IHT purposes too."
When someone passes away, if the contents of the ISAs are being passed to their spouse, they will get an additional ISA allowance, explained Sarah. This is known as an additional permitted subscription and this is equal to the value of cash or investments passed on. It means someone can get the tax benefits of the ISA allowance their partner has built up over the years.
Inheritance Tax - what you need to know
It's important to remember that very few families end up having to pay Inheritance Tax. The standard threshold for when Inheritance Tax starts is when an estate is valued at more than £325,000 - but there are exemptions which often mean this is higher for most people.
For example, there is no Inheritance Tax to pay when an estate is left to your spouse or civil partner, and if you give away your home to your children, you get an additional allowance of £175,000. If you are married or in a civil partnership, any Inheritance Tax allowance that isn’t used can be passed on when someone dies. This means a couple can potentially pass on as much as £1million without their estate being subject to Inheritance Tax.