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24 October 2019updated 09 Sep 2021 3:30pm

Could IHT wipe out 40 per cent of your ISA?

The tax-efficient investment specialist and CEO of Wealth Club discusses how a surprising number of wealthy ISA investors might be sleepwalking into an inheritance tax nightmare.

By Alex Davies

This article is linked to a Wealth Club report on how to make your ISA IHT free. For a free download of the full report click here.

Suppose you do everything by the book. You make the most of your ISA allowance. You make some sensible investment decisions. You do that every year for, say, 15 or 20 years.

In theory, you could well be on track to become an ISA millionaire or, at the very least, build a sizeable pot that you can pass on to your loved ones.

Sadly, that’s not necessarily the case.

To download our full report into how to make your ISA IHT free click here.

ISAs – the sting in the tail

If you’ve built up a large enough pot, a little-known ISA rule may throw a spanner in the works right at the end.

ISAs are very tax efficient when you are alive but could be subject to inheritance tax (IHT) when you die. That means up to 40 per cent of the fund you’ve worked hard to build over the years could end up in the taxman’s coffers, instead of benefitting your family or heirs.

There’s currently a mammoth £608 billion held in adult ISAs. At the last count, over 1.8 million people over 65 had ISA funds worth more than £50,000.

Of course, not all of them will need to worry about inheritance tax.

So, who might be at risk? IHT rules are complex but, as a rule of thumb, if your estate is worth more than £450,000, it might be eventually caught by IHT – either when you die or when your spouse dies, if later.

To clarify, your estate includes pretty much everything you own – from your house to your investments, car and jewellery – but usually not your pension.

Please note though: not only are IHT rules complex, they’re also subject to change and tax benefits and reliefs depend on circumstances. If you are in doubt, you should seek advice.

The tax take from inheritance hit a record high of £5.4 billion in 2018-19, HMRC data shows

How could you protect your ISA from IHT?

The easiest – and arguably the most enjoyable – way is to spend some of the wealth you’ve accumulated. But that might not be what you had in mind when you invested in an ISA.

Another option is to cash in some or all of your ISAs and give the proceeds away. This is simple enough but has drawbacks.

The obvious one is that the money is no longer yours. So, you couldn’t use it to fund potential costs further down the line (long-term care, for instance). Another significant snag is that when you give large sums away, it takes seven years for them to become completely free of IHT. Should you die before the seven years have passed, the IHT relief would be compromised.

A third option is to cash in the ISA and invest the proceeds in a trust.  However, the seven-year rule still applies, the money is no longer yours and this option can involve complicated legal paperwork and trust tax charges.

There is an alternative.

It’s relatively simple and quick – the IHT relief should kick in after two years rather than seven. Importantly, it allows you to keep control of your money – even make withdrawals if you need. The catch? It’s only for experienced investors, as the investment risks are higher

The choice for experienced investors

If you’re an experienced investor worried about IHT, you could consider an AIM Inheritance Tax ISA – you could either invest new money or transfer ISAs from previous years.

An AIM Inheritance Tax ISA works like an ordinary Stocks & Shares ISA, but, as the name suggests, it only invests in selected AIM shares.

Why specifically AIM shares? Many (but not all) AIM shares currently qualify for something called Business Property Relief, BPR in short.

BPR was originally created to allow family businesses to be passed on through the generations IHT free but it has been extended since, including to many AIM companies.

As a result, if you hold shares in those companies for at least two years and still hold them on your death, no IHT should be due on them. In addition, because they’re still in an ISA, any growth or income should also be tax free.

The IHT relief comes at a cost. AIM shares are more volatile and illiquid than those listed on the main market. So, an AIM Inheritance Tax ISA is typically considered riskier than an ordinary Stocks & Shares ISA invested in mainstream unit trusts and/or shares, hence why it’s only for experienced investors.

That said, the alternative could be a 40% tax bill when you die. If you’ve been prudent enough to shelter significant amounts from tax in an ISA, why let it fall prey to inheritance tax at the end?

Getting our free report could be the first step in preventing that. There is no obligation, and it is not a personal recommendation to invest. The report explains the main options, risks and benefits briefly and clearly, with an example showing how an AIM Inheritance Tax ISA might work in practice.

Please remember: not only are IHT rules complex, they’re also subject to change, and tax reliefs and benefits depend on circumstances. If you are in doubt, you should seek advice.

To download our full report into how to make your ISA IHT free click here.

Important note

This article, like our report and the service Wealth Club offers, is not advice or a personal recommendation. This is a quick summary of a complex subject and does not cover every nuance. You should not make – or refrain from making – any decision based solely on the content of this guide. If you are unsure an investment is right for you, please seek professional advice. We have made every attempt to ensure the information in this article is correct and accurate (Oct 2019) but cannot guarantee it. Please remember, tax benefits depend on circumstances. Tax rules can change. If in doubt, please seek specialist tax advice. Treasury review – The previous Chancellor asked the Office for Tax Simplification to review a range of aspects of IHT, including BPR. A report has been published in July 2019. It is as yet unknown when and if any of the recommendations will lead to a change in rules. Currently, investments qualifying for Business Property Relief should be free from IHT after two years.

© Wealth Club 2019. This financial promotion is issued by Wealth Club Limited and is a marketing communication. Wealth Club Limited is authorised and regulated by the Financial Conduct Authority, Register Number 725176, registered office is 4 Broad Plain, Bristol, BS2 0JP, United Kingdom.

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