ISAs offer a tax-free wrapper for savings, shielding them from income tax and capital gains tax. However, they are not exempt from inheritance tax (IHT).
On death, the value of an ISA is included in an individual’s estate, potentially attracting 40% IHT. Many ISA holders hesitate to gift their ISAs due to the loss of tax-free status, but from an IHT perspective, does gifting actually make financial sense?
Approximate Reading Time: 4 minutes
Topics Discussed:
- The key tax implications of gifting an ISA.
- A case study demonstrating the financial advantages of early ISA gifting.
Understanding the IHT Dilemma with ISAs
While ISAs grow tax-free, they remain liable for IHT upon death. This means that, despite their tax-efficient nature, ISAs could face a 40% tax hit before passing to beneficiaries.
By gifting an ISA during their lifetime, a saver removes it from their taxable estate, reducing future IHT exposure.
However, this action results in losing the tax-free ISA wrapper, meaning future income and gains become taxable for the recipient.
Key Tax Implications of Gifting an ISA
- IHT Relief: If the donor survives seven years, the ISA is completely removed from their estate.
- Immediate IHT Reduction on Growth: Any future growth after the gift is outside the estate, reducing the tax burden.
- Taper Relief: If the donor dies within three to seven years, taper relief progressively reduces the IHT rate.
- Loss of Tax-Free ISA Benefits: The recipient loses ISA tax efficiency, making future income and gains taxable.
If no gift is made, the entire ISA value is subject to 40% IHT upon death.
Geoffrey’s £1m ISA Decision
Case Study:
Geoffrey, aged 70, has a £1m ISA and is considering gifting it to his son, Sean. He wants to reduce IHT exposure but worries about losing the tax-free wrapper.
Financial Comparison
- If Geoffrey does nothing, the ISA faces 40% IHT, leaving Sean with £600,000.
- If Geoffrey gifts the ISA today and survives seven years, Sean keeps the full £1m tax-free.
- Even if Geoffrey dies within three years, taper relief reduces the tax burden.
The Numbers Are Clear
- If Geoffrey survives seven years, Sean gains £400,000.
- Even if he dies earlier, the ISA’s growth outside the estate still offsets IHT costs.
Early Gifting is Key
The best approach for IHT efficiency is gifting ISAs as early as possible. Many savers delay in hopes of years of extra tax-free growth, but procrastination often results in the entire ISA being taxed at 40%.
Summary
Gifting ISAs reduces inheritance tax exposure, even if it means losing the ISA’s tax-free benefits. The longer the donor survives post-gift, the greater the IHT savings.
Speak to Help Me Legal Solicitors for expert guidance on structuring your estate tax-efficiently.
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