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Passing an Isa to a spouse is to become more tax-efficient

Growth will be included in the allowance
November 24, 2017

Investors who plan to pass on individual savings accounts (Isa) to their spouses when they die will be able to do this more tax-efficiently from April next year 

Since 2015, individuals have been able to pass on the value of their Isa to a spouse or civil partner when they die. The surviving spouse is granted an additional one-off Isa allowance called an additional permitted subscription allowance equal to the value of whatever their spouse held in the Isa at the time of their death.

However, any growth in the Isa that takes place during the probate administration process is not included in this allowance. And the Isa wrapper itself also ceases at the point of death, meaning the usual tax-efficiency benefits are lost. As a result, any growth that occurs on the assets held in the account during the probate process may be subject to capital gains tax (CGT).

This causes two headaches for the surviving spouse. During the administration of the estate, growth in the Isa is exposed to taxation. And, although the Isa assets may be growing, the amount the surviving spouse receives in their additional permitted subscription is fixed at the Isa value at the time of their partner's death.

Sarah Coles, personal finance analyst at Hargreaves Lansdown, says: "The administration of a complex estate can take months, or even years. During this time, the Isa investments may continue to grow. If, for example, you have a £1m Isa portfolio growing at 5 per cent a year, you could end up with around £160,000 of growth over three years."

But the new rules will mean that when an investor dies their Isa will no longer lose its tax wrapper status. Instead, it will become a 'continuing account of a deceased investor' or continuing Isa. Although no money can be paid into it after the original account holder’s death, the assets within it can continue to grow tax-free. The account's status as a continuing Isa will last either until the administration of the estate is completed, the Isa is closed or three years have passed since the original account holder's death – whichever is sooner.

And the new rules will mean that the surviving spouse's additional permitted subscription Isa will be either the value of the Isa on the date of death or the value of the investments held within the account after it ceases to be a continuing Isa – whichever is higher.

Mrs Coles says: "At the moment, when probate is completed and the assets are released, you don't have to sell the assets in your deceased spouse's Isas - you can apply for your additional permitted subscription via an in specie transfer. If the shares have fallen in value since death, you can top them up to make up the full additional permitted subscription value. If the shares have risen in value, they will fulfil the additional permitted subscription and have some surplus.

"The surplus is essentially taxable profit and, if cashed in or transferred into an Isa as part of the annual allowance, will incur CGT, although this could be offset against the surviving spouse's annual allowance [currently £11,300]. Under the current rules you can only transfer an amount equal to the value of the assets in your spouse's Isa at the date of their death via your additional permitted subscription. But under the new rules you will be able to transfer all of it."

HM Revenue and Customs (HMRC) reports that around 300,000 Isa investors die each year, and this rule change should reduce the tax costs faced by some of their estates and beneficiaries. The inheriting spouses of investors who have large Isa holdings and whose estates may take quite a long time to administer after death, are most likely to benefit.  

"These changes get rid of an anomaly that was particular to the probate process, as assets have grown free of tax up to the point of death," says Colin Low, managing director of Kingsfleet Wealth. "We've had quite a few queries about this issue in the past few months, so it’s positive that there's been a resolution of the problem. Especially as I think more people are using the ability to pass on their Isa to their spouse on death."

Petronella West, director, private clients at Investment Quorum, adds: "The current additional permitted subscription system is messy, so by tidying up the legislation the government is making it easier for everyone dealing with probate issues. There is often a lot of paperwork involved when someone dies and things can get quite complicated, which can be difficult [for executors to deal with], especially when you are already distraught."

To make the job of your executors easier, she suggests you keep clear financial records, have written a will and organise your affairs and assets clearly. "The estates that are well planned are the ones where people will save a fortune in probate fees," she explains.