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How to secure your family’s future with an ISA

It’s said that two things in life are certain, death and taxes. Inheritance tax (IHT), then, was always inevitable. Yet many parents are putting their family at risk of large, shock tax bills by not understanding the basic rules.

Secure your family’s future with an ISA: Summary Table

❓ What is the ISA allowance?£20,000 each tax year
⚰️ What happens to my ISA if I die?Your spouse or civil partner will inherit your ISA without paying inheritance tax
⚖️🆓 What is the tax-free gift allowance?£3,000 each tax year
🧾 Inheritance tax applies to?Estates worth over £325,000

If you’re helping your adult children afford a deposit for their first home, don’t worry; you’re not alone. Nearly a third of first-time buyers are now getting financial help from their relatives, with an increasing number turning to their grandparents, recent Santander research shows. But generous lump-sum cash gifts can cause your family a lot of trouble later down the line.

Inheritance tax

If you’re giving your child over £3,000 in one year, you’ll have to live another seven years for this not to be counted as part of your estate, which could land your children with a hefty inheritance tax bill.

This £3,000 annual tax-free gift allowance can be carried over to the next 12 months if unused, although only for one year. If your child is thinking of walking down the aisle, the kind people at HMRC let you increase this to a one-off £5,000.  

Including property, money and possessions, an individual’s estate can be worth £325,000, plus £100,000 if a property is being passed onto a child from April 2017 – this will soon rise to £175,000. Anything above this is taxed at 40%. By 2020, a couple will be able to pass on an estate worth £1 million tax free.

The rules for ISA inheritance have also had a much-needed overhaul. It’s a grim statistic, but 150,000 married ISA savers die each year. Until recently, these savings were not protected by their income tax and capital gains tax wrappers when passed onto their spouse, again leaving the partner exposed to mammoth tax bills.

Former Chancellor George Osborne got rid of this ISA death tax in 2014 and now ISAs keep their wrapper when passed on. Unfortunately, an ISA left to anyone who isn’t your spouse is still exposed to inheritance tax if part of an estate worth more than the tax-free threshold.

If you’re organised, giving smaller, regular amounts to your children might be more tax efficient than a one-off lump sum. As long as you’re in work and the cash comes from your after-tax income, not your savings, you can give your children £400 a month tax free, as you’ve already paid up in the eyes of the taxman. Don’t be too kind though, you’re not allowed to sell your home so your children can live the high life.  

How an ISA can help

Whether your children are saving for their first home, wedding or a holiday, they should put these regular gifts straight to work in a Stocks & Shares ISA to make the most of their annual tax-free allowance. From April 2017, the ISA allowance is £20,000.

The Cash ISA has been incredibly popular since its launch 20 years ago, but in an era of rock-bottom interest rates, it’s quickly losing its appeal. With inflation expected to run at 2.4% this year,¹ the cash you’re giving your children now could have less purchasing power in a year’s time. The best easy access ISA rate is just 1.01%.²

This makes no financial sense, yet only around 20% of savers make the most of a Stocks & Shares wrapper, according to the latest government data.

Of course, there is risk attached to investing in the market, but careful planning and portfolio diversification could provide better returns than your money gathering dust in a Cash ISA.

It may seem complicated, but you just need to follow these three simple rules:

  1. Set up a Stocks & Shares ISA for you and your family
  2. Decide whether lump-sum gifts or regular investments are more appropriate for your circumstances
  3. Protect any investments with your £20,000 ISA wrapper before the tax year ends.

1 Inflation forecasts from the Office for Budget responsibility, March 2017
2 Top easy access cash ISA according to Money Saving Expert

Contacting a tax adviser may be a good idea if you are unsure of your tax circumstances.


What happens when I inherit an ISA?

If you are inheriting an ISA as a spouse or civil partner, you will inherit the ISA tax free as a one-off additional ISA allowance. The tax-free amount inherited is equal to the value of the ISA upon death or when the account was closed. If your spouse or civil partner died from 3 December 2014 to 5 April 2018, then inheritance tax is imposed on the ISA investments as it will form part of their estate. For other beneficiaries, ISAs lose their tax-efficient status. Any interest earned will be subject to income tax, capital gains tax upon the sale of assets, and inheritance tax if ISA is part of an estate worth over £325,000.

Can I transfer my ISA to my family?

No, you can not transfer your ISA to a family member. You must sell all stocks and shares investments in an ISA and transfer the funds (including cash investments) to your family member. You can not transfer your ISA to an account bearing a different name.

Can I set up an ISA for my child?

Yes, you can open a Junior ISA for your child. The parent will be responsible for the account until the child turns 18. Once the child turns 18, the Junior ISA is converted to an Adult ISA, and the child takes charge of the account. Anyone, including grandparents, can contribute to a Junior ISA as long as the ISA annual allowance of £4,000 is not exceeded.