Are ISAs Free of Inheritance Tax? The Real Story Uncovered

ISAs are a go-to for tax-free savings, but here's something that catches a lot of people off guard: ISAs aren’t free from inheritance tax (IHT). Seems unfair, right? You spend years building a tax-free pot, and then when you pass on, the taxman still wants a slice—unless you've got your facts straight.

If you die, your ISA forms part of your estate. That means if your estate—everything you own—adds up to more than the current IHT threshold (£325,000 as of today), your ISAs get counted in the tax bill, just like your house or investments. The only exception is if the ISA goes directly to your spouse or civil partner. Then, good news: they get something called an 'Additional Permitted Subscription,' letting them top up their own ISA with what you left behind, still tax-free.

• What Happens to Your ISA When You Die?
• Are ISAs Exempt from Inheritance Tax?
• How Inheritance Tax is Calculated on ISAs
• Transferring ISAs to a Spouse or Civil Partner
• Tips to Make ISAs Work for Your Family
• Pitfalls and Watchouts with Inheritance and ISAs

What Happens to Your ISA When You Die?

When you die, your ISA doesn’t just disappear or stay magically tax-free forever. It becomes part of your estate. This means it gets included with everything else you own like property, savings, and valuables. Anyone handling your estate—usually your executor—must tell your ISA provider about your death, and your ISA is then ‘frozen’. No more money goes in, and except for a few days of interest or returns, it stops growing tax-free from the date of your death.

The provider will move your ISA into a cash account while they wait for paperwork, or keep it invested but stop calling it an ISA. During this admin phase, any interest or returns might still get paid—but these are now taxable, not sheltered by ISA rules. Once your estate is sorted, your beneficiaries get the money, but they don’t get to keep it in an ISA unless they’re a spouse or civil partner using a special rule called the Additional Permitted Subscription (APS).

To make this clearer, here’s what typically happens, step by step:

• Your ISA account is frozen on the date of your death.
• Any interest or investment growth before that date stays tax-free.
• After your death, interest earned or investments rising in value are taxed as normal income or capital gains for your estate.
• Your executor tells the provider what to do next (transfer out, cash out, etc.).
• If you leave your ISA to your spouse or civil partner, they get an APS—meaning they can pay in up to the value of your ISA into their own. Anyone else gets the cash, not the ISA benefits.

Here’s a quick look at what happens to a ISA after death and how it’s taxed:

This process takes time—sometimes months. So, families need to be aware: any investment changes after death can trigger a tax bill. Proper planning helps avoid nasty surprises.

Are ISAs Exempt from Inheritance Tax?

Let’s cut through the confusion: ISAs are not exempt from inheritance tax. Even though you don’t pay income or capital gains tax on the growth inside your ISA during your lifetime, when you die, HMRC treats the money in your ISA just like everything else you own. Your ISA simply becomes another part of your estate as far as inheritance tax is concerned.

If your total estate—your house, cash, investments (including ISAs), and possessions—tops £325,000, IHT might apply. The standard tax rate is 40% on anything above that threshold. So, the ISA tax perks stop at death, unless your savings go to your spouse or civil partner.

Here’s an example: If you leave £100,000 in ISAs and your total estate is worth £400,000, £75,000 of your estate would be subject to that 40% inheritance tax. Your loved ones might lose £30,000 of your ISA savings to HMRC if there’s no other relief or gift exemption in play.

Remember, the only time an ISA avoids inheritance tax at death is if it passes to your spouse or civil partner. They can inherit the value of your ISA and get what’s called an Additional Permitted Subscription (APS). This means they can put your ISA money into their own ISA and keep the tax-free benefits rolling. For anyone else—kids, siblings, friends—the full value of your ISA piles onto the estate for tax purposes.

Bottom line—don’t assume that just because your ISA was tax-free while you were alive, it’ll be tax-free when you pass it on. That’s one of the most common misconceptions and can trip people up big time when planning for their family’s future.

How Inheritance Tax is Calculated on ISAs

Here's the deal: when you pass away, HMRC adds up everything you own—yes, that includes ISA accounts—to work out your estate’s total value. If the total (ISA savings plus your home, cash, and other investments) is over the £325,000 threshold (that’s called the ‘nil-rate band’), anything above that is hit with 40% inheritance tax. Yikes, right?

Your ISA doesn’t get a free pass just because it was tax-free while you were alive. The tax-free perks (no income or capital gains tax) end the day you die. From then on, all your ISA balances count toward your estate for IHT calculation. The accounts stop being ISAs on your date of death, but any interest or gains made between then and when the money is handed over to your heirs might still get taxed in different ways.

Check out how that works in reality if you’re single and leave behind:

In this case, your estate would be £450,000. Subtract the £325,000 allowance, and that’s £125,000 subject to 40% tax. Your beneficiaries could see up to £50,000 (ouch!) go straight to the taxman purely from IHT.

If you leave your entire estate to your spouse or civil partner, the inheritance tax doesn't bite—spouses are exempt. Plus, anything you don’t use of your nil-rate band can be transferred, so your partner gets an even bigger allowance. But for everyone else, your ISAs get bundled in with everything for that 40% calculation.

• ISAs lose their tax-free status after you die—don’t forget this!
• It’s your executor’s job to include the value of your ISAs in your estate’s value for IHT forms.
• If you want your family to avoid a nasty bill, it’s worth looking into trusts or giving gifts while you’re still around—though these come with their own rules and risks.

Transferring ISAs to a Spouse or Civil Partner

So, what happens to your ISA if you die and you’re married or in a civil partnership? Here’s where you actually get a break from the usual inheritance tax rules. The government gives your spouse or civil partner an 'Additional Permitted Subscription' or APS. That phrase is a mouthful, but it’s a simple idea: your partner can boost their own ISA by an amount equal to all the ISAs you held when you died—without losing any of the normal tax perks.

Here’s how it usually works:

• Your partner notifies the ISA provider about your death and their relationship to you.
• The provider confirms the value of your ISAs at your date of death.
• Your partner has up to three years (sometimes a little longer, depending on the situation) to use this APS allowance and add that amount to their own ISA savings, tax-free.

This rule is a game-changer—it means your spouse can keep your savings sheltered from tax, instead of those savings just getting dumped into your estate and possibly facing inheritance tax. No need to jump through complicated hoops or hire a lawyer. Just talk to your ISA provider, and they’ll usually walk your partner through the steps.

But—and this is a big one—if the ISA goes to kids, friends, or anyone else who isn't your spouse or legal partner, the APS doesn’t apply. In those cases, the value of your ISA just becomes part of your estate, and inheritance tax rules kick in if your estate’s over the threshold.

Tip: If you’re married or in a civil partnership and care about keeping your hard-earned ISA savings safe, make sure your wills are up-to-date and your partner knows to claim the APS. It’s one of the few parts of the tax system that’s actually pretty straightforward, but only if you handle it the right way.

Tips to Make ISAs Work for Your Family

Making the most of your ISA for your family isn’t just about picking the best interest rate. There are a few simple moves you can make now to help your loved ones get the best value out of your savings later on.

• Name your beneficiaries smartly. For stocks and shares ISAs, while you can’t name a beneficiary like you would with a pension or life insurance, talk to your spouse or civil partner about the ‘Additional Permitted Subscription’—they can inherit your ISA allowance and keep the tax perks if you plan ahead. This only works for married couples or civil partners, not for children or unmarried partners.
• Avoid missing allowances. If your spouse dies and you’re entitled to the APS allowance, use it within the time limit or you might miss out. You usually get up to three years from the date of death to use it, or up to 180 days after the estate is settled, whichever is later.
• Consider gifting if your total estate is close to the IHT threshold. You can gift up to £3,000 a year free of inheritance tax, which could help shrink your estate and reduce the tax bill on ISAs and other assets.
• Use ISAs together if you’re a couple. If both partners have ISAs, you’re potentially doubling your tax-free savings and inheritance allowance. This is a simple way to multiply the benefit without jumping through legal hoops.
• Stay on top of yearly limits. For 2025, you can put up to £20,000 into an ISA. Don't miss that fresh allowance each tax year—once it’s gone, it’s gone.

Here’s a quick snapshot of inheritance tax thresholds and ISA rules (as of May 2025):

One last reminder: ISA savings don’t dodge inheritance tax just by existing, so set up your estate with these rules in mind. It’s worth checking in with a financial adviser if you’re unsure—sorting it early saves your family lots of hassle later.

Pitfalls and Watchouts with Inheritance and ISAs

There’s a lot people get wrong about ISAs and inheritance. One common mistake is thinking your ISA is totally outside the reach of inheritance tax. The truth? ISA savings get bundled in with the rest of your estate. If you go over the £325,000 inheritance tax threshold, anything above that is taxed at 40%. Ouch.

Here are a few things to keep your eyes on:

• Timelines matter: ISAs keep growing tax-free until your date of death. After that, they get 'frozen' for tax purposes. Your estate has up to three years to close or move the account. Any gains made after you pass away are fully taxable, so it’s smart for executors to act quickly.
• Spouse/civil partner transfer is not automatic: Just because you’re married or partnered doesn’t mean the ISA will magically become theirs tax-free. They must use an ‘Additional Permitted Subscription’ (APS) and fill out paperwork. Miss the window, and you lose the benefit.
• Too much focus on ISA, not enough on whole estate: Your house, savings, and other investments all count towards your inheritance tax bill, not just ISAs. Some folks pile everything into ISAs, thinking it’s safe, but it won’t protect you from IHT if you’re already over the limit.
• ISAs can’t just be split: You can’t just hand off bits of your ISA to whoever you want tax-free. The rules are strict. If it goes to anyone besides your spouse or civil partner, those savings could get taxed just like any other chunk of your estate.
• Poorly planned wills: If your will isn’t clear or up-to-date, your ISA might not go to who you expect, or the process can drag on, causing headaches for your family (and extra tax). Always keep your will sorted and chat to a pro if your situation’s at all complicated.

In short, don’t get caught out thinking ISAs are a magic bullet for inheritance tax. Keep up with the paperwork, know the deadlines, and look at the bigger picture of your whole estate. That way, your savings really work for your family when it counts.