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A widow inherits an ISA. What now?

Written by Jessica Franks
22 May 2020 Reading time: 4 mins

Using an additional permitted subscription as part of a client’s estate planning

In this article, I want to share an example of inheritance tax planning that involves a client’s ISA, by making use of an additional permitted subscription (APS).

What are additional permitted subscriptions?

Since April 2015, surviving spouses of ISA investors have been able to make additional ISA subscriptions over and above their own ISA allowance, by effectively being given a one-off ISA allowance equivalent to the value of their spouse’s ISA when they died.

This extra ISA allowance is available to a surviving spouse who inherits their spouse’s ISA AND to one who doesn’t. If the assets from within an ISA are left to the children, for example, the surviving spouse can choose to invest into an ISA using any source of funds up to the value of their spouse’s ISAs when they died. This is on top of their own £20,000 annual ISA subscription allowance.

How an APS helped Sylvia when she inherited her husband’s assets

So let’s see how using this APS ISA allowance might work in practice. Sylvia has just become a widow. She is sorting out the estate of her late husband, Gordon, who died unexpectedly, leaving his entire estate to her, including his Stocks and Shares ISA worth £150,000. Up to now, neither Gordon nor Sylvia have undertaken any estate planning. But Gordon’s passing has encouraged Sylvia to look into how best to pass wealth on to their three children.

Sylvia meets with Martin, her financial adviser. Martin explains that the value of the house will use up all of Sylvia’s inheritance tax allowances, including the nil-rate band and residence nil-rate band she inherited from Gordon. That means that yes, there is a need to do some planning if Sylvia wants to reduce the amount of inheritance tax that her estate will pay when she passes away.

Martin talks through the options available to Sylvia. When it comes to what to do with Gordon’s ISA, Sylvia explains that researching and managing the investments in his ISA was something Gordon used to enjoy very much. As a couple, they had never touched those assets as they could easily cover their living costs from other sources, and they understood the value of the lifetime tax benefits that would be lost if wealth was withdrawn from the wrapper. Gordon had mentioned to Sylvia on several occasions that, in his mind, his ISA was a pot of money he was building up for the kids. If possible, Sylvia would like to leave this ISA pot to their children when she dies.

Martin explains that, due to the APS rules, Sylvia has the opportunity to reinvest some or all of the value of her late husband’s ISA investments into a new ISA of her choosing. This will ensure that she will benefit from the lifetime tax benefits such as tax-free interest, dividends and growth that an ISA wrapper affords.

A way to keep ISA funds invested while planning for inheritance tax

Without any planning, despite the generous lifetime benefits of an ISA, a new ISA taken out by Sylvia will be subject to inheritance tax when Sylvia passes away. At 40%, that would mean an inheritance tax bill of £60,000 on the ISA pot alone, based on its current value. Assuming the pot was split equally, then each of Gordon and Sylvia’s three children would get £30,000. That compares to £50,000 each if the ISA were zero-rated for inheritance tax.

Martin makes an assessment based on Sylvia’s objectives, attitude to risk, capacity for loss and circumstances, including the fact that she doesn’t need to access the amount she inherited from Gordon’s ISA, and the fact that she is keen for that money to stay invested in stocks and shares. He suggests she opens a type of AIM Inheritance Tax ISA that is specifically managed to invest into companies that qualify for Business Relief (BR).

BR is a longstanding relief from inheritance tax designed to be an incentive to take on the risk of investing in unquoted or Alternative Investment Market (AIM)-listed businesses that meet certain qualifying criteria. APS rules mean Sylvia can make a one-off new investment in such an ISA up to the value of Gordon’s ISA pot. She would also be able to make new annual subscriptions in the usual way of up to £20,000 each year, or to transfer over any ISAs held in her own name if she wanted to. 

Once Sylvia has held this ISA for two years, the BR-qualifying shares can be passed to her children free from inheritance tax when she dies.

Martin makes sure Sylvia understands that this type of ISA will be significantly higher risk than Gordon’s existing Stocks and Shares ISA. Under the circumstances, Sylvia is comfortable with this.

Martin explains the risks

Martin explains that Sylvia should continue to regard this as a long-term investment. The value of a BR-qualifying ISA, and any income from it, could fall or rise, meaning she may not get back the full amount she invests. So while that £150,000 could grow, she could also end up with less to pass on. Martin also explains that the share price of AIM-listed shares can be more volatile than that of the shares of companies listed on the main market of the London Stock Exchange. They may also be harder to sell.

As for inheritance tax, Martin explains to Sylvia that HMRC will assess whether each company in her new portfolio qualifies for BR after her death. Entitlement to claim the relief will depend on whether a company qualifies at that time. The value of BR to Sylvia’s estate will depend on her personal circumstances. As with all tax legislation, the rules around BR could change in the future.

Find out more

To see how this type of investment works in practice, visit the Octopus AIM Inheritance Tax ISA web page.