Consumer champion Martin Lewis has issued a stark warning to millions of ISA savers across the UK, revealing that their carefully accumulated tax-free savings could be subject to a hefty 40 per cent tax charge from HMRC upon their death.
The Crucial ISA Inheritance Rule Explained
Speaking on a recent episode of his BBC podcast, the founder of MoneySavingExpert.com tackled a listener's question about what happens to ISA allowances and savings when a person dies. The listener, in his early 60s and in the 40 per cent income tax bracket, was concerned about the implications for his wife, who is in the 20 per cent bracket.
Martin Lewis provided crucial clarity: "You can effectively leave your ISA allowance to your spouse," he stated, specifying that 'spouse' means a legally married partner or civil partner, and does not include common-law partners. "What happens when you do is, in practical terms, you leave them your ISA, and they get what is called an additional ISA allowance."
ISA Allowance Changes and the Inheritance Tax Trap
This warning comes against the backdrop of significant changes to ISA rules announced by Chancellor Rachel Reeves in the Autumn Budget. Currently, Brits can save £20,000 per year tax-free in an ISA. However, this allowance will be reduced to £12,000 from April 2027, with the remaining £8,000 being ring-fenced for Stocks and Shares ISAs. Those aged 65 and over will be exempt from this change and can continue to save £20,000 in a Cash ISA.
Lewis emphasised a critical and often misunderstood point: while ISAs offer tax-free growth during your lifetime, they do not provide an automatic exemption from Inheritance Tax (IHT). "It's worth noting that money left in an ISA is still subject to inheritance tax," he explained. "The ISA does not exempt it from inheritance tax, so if you were due to pay inheritance tax, whether it's in or out of an ISA, it still counts as assets for inheritance tax reasons."
Protecting Your Legacy: Understanding Tax-Free Thresholds
This means the value of your ISA pots is added to your total estate. If the total value of your estate exceeds the nil-rate band, it could be subject to IHT at 40%. Currently, each individual can pass on assets worth up to £325,000 tax-free, with an additional £175,000 Residence Nil-Rate Band available if passing a main home to direct descendants like children or grandchildren.
Lewis sought to reassure couples on one key point: the immediate tax bill for the surviving spouse. He confirmed that if a person leaves their ISA savings to their spouse, the surviving partner would not have to pay income tax on that money immediately. The process of transferring the ISA allowance is designed to be relatively straightforward when assets are left to a spouse.
However, the ultimate exposure to the 40% inheritance tax charge remains a vital piece of financial planning that many ISA holders may have overlooked, making Lewis's intervention a timely reminder to review one's estate and seek professional advice where necessary.
