Are ISAs Subject to Inheritance Tax?

At Towerstone, we provide specialist Inheritance Tax accountancy services for families and executors. We have written this article to explain how ISAs are treated for IHT, helping you make informed decisions.

In my experience as a chartered accountant specialising in self assessment and personal tax planning, ISAs are one of the most misunderstood savings vehicles when it comes to inheritance tax. I regularly speak to clients who assume that because ISAs are tax free during their lifetime, they must also be tax free when they die. Others have heard snippets about spouses inheriting ISAs tax free and believe the same applies to children or other beneficiaries.

In this article, I am going to explain clearly and honestly whether ISAs are subject to inheritance tax, how the rules actually work in the UK, and what practical steps you can take to reduce the tax burden on your family. I will also share insights from real client scenarios and my professional experience, because inheritance tax is not just a technical subject, it is a deeply personal one.

By the end of this guide, you should understand how ISAs are treated on death, what happens to them when they form part of an estate, how the rules differ for spouses and civil partners, and how you can plan ahead sensibly without relying on myths or half truths.

What is an ISA and why are they so popular?

An Individual Savings Account, more commonly known as an ISA, is a tax efficient wrapper that allows you to save or invest without paying income tax or capital gains tax on returns. From experience, I can say that ISAs are one of the most valuable tools available to UK savers, especially those who have already used their pension allowances or want flexibility.

There are several types of ISA available in the UK, including:

Cash ISAs, which work like tax free savings accounts

Stocks and Shares ISAs, which allow investments in funds, shares, and bonds

Innovative Finance ISAs, which include peer to peer lending

Lifetime ISAs, which are designed for first time buyers or retirement saving

Each tax year, individuals have an ISA allowance, which caps how much they can contribute across all ISAs combined. Once money is inside an ISA, it can grow free of income tax and capital gains tax for life.

In my opinion, this is what makes ISAs so attractive, they provide simplicity, flexibility, and tax efficiency without the long term restrictions that come with pensions.

However, and this is crucial, the tax free status of ISAs during your lifetime does not automatically carry over after death.

Understanding inheritance tax in the UK

Before we get into ISAs specifically, it is important to understand how inheritance tax works in general.

Inheritance tax, often shortened to IHT, is a tax charged on the estate of someone who has died. The estate includes all assets owned at death, such as property, savings, investments, and personal possessions.

As things stand, inheritance tax is charged at 40 percent on the value of the estate above the available nil rate band. The standard nil rate band is £325,000, although this can be higher if certain conditions are met, such as passing a home to direct descendants.

From experience, one of the biggest misconceptions I see is people thinking inheritance tax only applies to the very wealthy. In reality, rising house prices have pulled many ordinary families into the inheritance tax net.

The rules around inheritance tax are set and administered by HM Revenue and Customs, with guidance published on GOV.UK. While the core principles are straightforward, the detail can become complex very quickly, especially when different asset types are involved.

Are ISAs subject to inheritance tax?

The short and honest answer is yes, ISAs are subject to inheritance tax.

In my experience, this is often a surprise to people. During your lifetime, ISAs are completely sheltered from income tax and capital gains tax, but when you die, the value of your ISA becomes part of your estate for inheritance tax purposes.

This means that unless an exemption applies, the value of your ISA at the date of death is added to your estate and may be taxed at 40 percent if the estate exceeds the available allowances.

There is no special inheritance tax exemption for ISAs themselves. The ISA wrapper effectively ends on death, and from a tax perspective, the assets inside are treated like any other savings or investments.

This applies regardless of whether the ISA is a cash ISA, stocks and shares ISA, or another type.

What actually happens to an ISA when you die?

When someone dies, their ISA does not simply disappear or pass automatically to a beneficiary in the same way pensions often do.

From experience dealing with estates, the process usually looks like this:

The ISA provider is notified of the death

The ISA is frozen, meaning no further contributions or investments can be made

The value of the ISA at the date of death is calculated

That value forms part of the deceased’s estate for inheritance tax purposes

The ISA wrapper itself effectively ceases at the date of death. Any income or gains that arise after death may become taxable, depending on what happens next and how quickly the estate is administered.

In my opinion, this is where planning becomes so important. The tax treatment after death depends heavily on who inherits the ISA and how it is handled.

What is the Additional Permitted Subscription for spouses?

There is one major exception to the inheritance tax exposure of ISAs, and it applies to spouses and civil partners.

When an ISA holder dies, their surviving spouse or civil partner may be entitled to an Additional Permitted Subscription, often referred to as the APS.

The APS allows the surviving spouse or civil partner to increase their own ISA allowance by the value of the deceased’s ISA at the date of death. This is a powerful and often misunderstood benefit.

From experience, many people incorrectly believe that the ISA itself transfers tax free. That is not quite right. What actually happens is:

The ISA value still forms part of the deceased’s estate

However, transfers between spouses are exempt from inheritance tax

The surviving spouse receives an extra ISA allowance equal to the deceased’s ISA value

This means the surviving spouse can rebuild the ISA tax free in their own name, even if they already use their full annual ISA allowance.

In practice, this can preserve the tax free status of ISA savings across generations, but only between spouses or civil partners.

Do ISAs pass to children tax free?

This is one of the most common questions I am asked, and the answer is no.

If an ISA is left to children, grandchildren, or any other beneficiary who is not a spouse or civil partner, the value of the ISA is fully included in the estate for inheritance tax purposes.

From experience, I have seen families caught out by this, especially where large ISAs have been built up over decades. A six figure ISA portfolio can easily create a significant inheritance tax bill if it pushes the estate over the available thresholds.

While the beneficiary will inherit the cash or investments from the ISA, they will not inherit the ISA wrapper itself. Once distributed, the assets lose their tax free status and any future income or gains may be taxable in the beneficiary’s hands.

How ISAs compare to pensions for inheritance tax

In my opinion, this comparison is crucial to understanding effective estate planning.

Pensions are often far more inheritance tax efficient than ISAs. In most cases, defined contribution pensions sit outside the estate for inheritance tax purposes. This means they can often be passed on without triggering inheritance tax, particularly if death occurs before age 75.

ISAs, by contrast, are always part of the estate, unless the spouse exemption applies.

From experience advising clients, this often leads to a counterintuitive conclusion. In many cases, it makes sense to spend ISA savings first in retirement and preserve pension funds for later life or inheritance.

This is not a rule that applies universally, but it is a strategic consideration that should not be ignored.

Do ISAs qualify for any inheritance tax reliefs?

Generally speaking, ISAs do not qualify for specific inheritance tax reliefs such as business relief or agricultural relief.

However, there is an important nuance worth mentioning. If an ISA holds shares in qualifying AIM listed companies that meet the conditions for business relief, there may be scope for inheritance tax relief after two years of ownership.

In my experience, this is an area where people need to be extremely cautious. AIM investments carry higher risk, and inheritance tax planning should never override suitability or risk tolerance.

That said, for some clients, AIM ISA portfolios form part of a broader inheritance tax mitigation strategy, particularly where large estates are involved.

Lifetime ISAs and inheritance tax

Lifetime ISAs are often misunderstood when it comes to inheritance tax.

From a tax perspective, Lifetime ISAs are treated in the same way as other ISAs on death. The value forms part of the estate and is subject to inheritance tax unless an exemption applies.

Any government bonus received during the saver’s lifetime is included in the value of the estate. There is no special inheritance tax exemption for Lifetime ISAs.

In my opinion, this is an important consideration for younger savers who may be using Lifetime ISAs for long term planning. While they are excellent tools for first time buyers, they should not be relied upon as inheritance tax shelters.

Can you put ISAs into trust?

A question I am sometimes asked is whether ISAs can be placed into trust to avoid inheritance tax.

The short answer is no, not directly.

You cannot place an ISA into trust without first withdrawing the funds, which would remove the ISA wrapper. Once withdrawn, the funds may be placed into trust, but this is then subject to the usual inheritance tax rules around lifetime transfers and potentially chargeable transfers.

From experience, this often creates more problems than it solves unless done as part of a carefully structured estate plan.

Practical inheritance tax planning with ISAs

In my experience, the most effective inheritance tax planning with ISAs is not about trying to make ISAs exempt, because they are not, but about integrating them sensibly into a wider strategy.

Some practical considerations include:

Using ISA savings during retirement rather than letting them accumulate unnecessarily

Prioritising pension preservation where appropriate

Making use of annual gifting allowances using ISA income or withdrawals

Ensuring wills are up to date and reflect ISA intentions

Understanding the spouse exemption and APS rules fully

From experience, small adjustments made early can significantly reduce the eventual tax burden.

Common ISA inheritance tax myths I see all the time

Over the years, I have encountered many misconceptions around ISAs and inheritance tax. Some of the most common include:

ISAs are tax free even after death

ISAs pass to children without tax

Naming a beneficiary avoids inheritance tax

ISAs work like pensions for estate planning

In my opinion, these myths persist because ISA providers quite rightly focus on lifetime tax benefits, but rarely emphasise what happens on death.

The importance of up to date wills and nominations

Although ISAs do not allow binding beneficiary nominations in the same way pensions do, having a clear and up to date will is essential.

From experience, I have dealt with estates where ISA intentions were unclear, leading to delays, family disputes, and unnecessary tax complications.

A well drafted will ensures that ISA proceeds are distributed according to your wishes and integrated properly into your estate plan.

Should inheritance tax concerns stop you using ISAs?

In my opinion, absolutely not.

ISAs remain one of the most flexible and valuable savings vehicles available in the UK. Their lifetime tax advantages are significant, and for many people, they form a core part of financial security.

However, they should be used with open eyes. ISAs are not inheritance tax shelters, and relying on them as such can lead to disappointment.

From experience, the best outcomes come when ISAs are used alongside pensions, property planning, and sensible gifting strategies.

Key Takeaways

Are ISAs subject to inheritance tax? Yes, in most cases they are.

While spouses and civil partners benefit from generous exemptions and additional ISA allowances, ISAs left to anyone else will usually be included in the estate and potentially taxed at 40 percent.

In my professional opinion, understanding this distinction is vital. ISAs are excellent for building wealth, but they are not a substitute for proper estate planning.

From experience, the families who fare best are those who plan early, understand the rules, and take advice tailored to their circumstances rather than relying on assumptions.

If there is one takeaway I would emphasise, it is this. Tax efficiency during life and tax efficiency on death are not the same thing, and successful planning requires understanding both.

If you get that balance right, ISAs can remain a powerful and positive part of your financial legacy rather than an unexpected tax burden for those you leave behind.

If you would like to explore related Inheritance Tax guidance, you may find how do the rich avoid inheritance tax and how much is inheritance tax useful. For broader inheritance tax guidance, visit our inheritance tax hub.