Financial guru Martin Lewis has issued a critical alert to millions of savers across the UK, highlighting a potential 40% tax trap that could affect money held in Individual Savings Accounts (ISAs) upon death.
The Inheritance Tax Trap for ISA Savings
In a stark reminder, Lewis clarified a common misconception: the valuable tax-free wrapper of an ISA does not shield the assets from Inheritance Tax (IHT). This means when the account holder passes away, the total value of their ISA is added to their estate for IHT purposes. If the estate's value exceeds the available thresholds, the savings could be subject to a levy of 40%.
"People often think their ISA is completely protected, but it's vital to understand that the tax-free status applies to income and capital gains during your lifetime, not to IHT after death," Lewis explained. This rule applies regardless of whether the money is held in a Cash ISA or a Stocks and Shares ISA.
Spousal Transfers and the Risk to Others
There is, however, a crucial safeguard for married couples and civil partners. Lewis detailed that a surviving spouse or civil partner receives an "additional permitted subscription" allowance. This allowance matches the value of the deceased partner's ISA, allowing the survivor to reinvest the funds and maintain their tax-free status without triggering an income tax bill.
The situation changes dramatically if the ISA is left to anyone else, such as children or other relatives. The funds immediately lose their ISA status. Once the probate process is complete, the beneficiary would have to pay income tax on any future interest or growth generated by the inherited sum, potentially at their highest marginal rate.
Lewis also reminded savers that unused IHT allowances can be transferred between spouses or civil partners, meaning a couple can potentially shield up to £1 million from the tax when the second partner dies.
Upcoming Changes to Annual Allowances
This warning comes alongside significant planned changes to ISA rules. The government has announced that from April 2027, the annual tax-free deposit allowance for a Cash ISA will be reduced from £20,000 to £12,000.
The remaining £8,000 of the £20,000 total annual allowance must be placed into a Stocks and Shares ISA. This move is seen as an incentive for savers to consider investment-based products. An important exemption exists for older savers: Britons aged 65 and over will retain the full £20,000 Cash ISA allowance, protecting those who typically prefer lower-risk, cash-based savings.
Martin Lewis's combined alert serves as a powerful prompt for financial planning. Savers are urged to consider their ISA holdings within the broader context of estate planning, understand the implications for their beneficiaries, and prepare for the forthcoming changes to annual contribution limits.
