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ISA (Individual Savings Account)

Also known as: Individual Savings Account, Tax-Free Savings

Definition

An ISA (Individual Savings Account) is a UK tax-efficient savings or investment account where income and growth are free from income tax and capital gains tax up to an annual £20,000 limit.

Understanding ISAs is crucial for estate planning because they count toward your estate value for Inheritance Tax purposes despite being tax-free during your lifetime—a common misconception that catches many people by surprise.

What Does ISA Mean?

Under the Individual Savings Account Regulations 1998, ISAs are tax-efficient accounts allowing UK residents to save or invest up to £20,000 per tax year (2025/26) without paying income tax on interest or dividends, or capital gains tax on growth. Four types exist: Cash ISAs (like savings accounts), Stocks & Shares ISAs (for investments), Innovative Finance ISAs (for peer-to-peer lending), and Lifetime ISAs (for first-time home buyers or retirement with a 25% government bonus). The annual allowance has remained £20,000 since 2017 and is confirmed at this level until April 2030. Since April 2024, you can open multiple ISAs of the same type in a single tax year, whereas previously you were limited to one of each type per year.

Many people hold ISAs believing they offer complete tax exemption, but this creates serious estate planning complications. While ISAs are free from income tax and capital gains tax during your lifetime, they absolutely count toward your estate value for Inheritance Tax purposes. Sarah, 58, diligently saved £180,000 across three ISAs over 20 years. Combined with her £280,000 home and £15,000 in regular savings, her total estate reaches £475,000. This exceeds the £325,000 Inheritance Tax threshold by £150,000, creating a £60,000 tax bill (40% of £150,000) for her two adult children. Sarah assumed her "tax-free" ISAs wouldn't create tax liability—a misconception that could have been avoided with proper estate planning.

ISAs receive special treatment when you die. Your ISA becomes a "continuing ISA" that maintains its tax-free status for up to 3 years after your death (or until estate administration completes, whichever is sooner). No new contributions can be made during this period, but the account continues earning interest or investment returns without income tax or capital gains tax applying. Crucially, if you're married or in a civil partnership, your spouse receives an Additional Permitted Subscription (APS) allowance equal to your ISA's value on death. David's £85,000 Stocks & Shares ISA qualified Emma, his wife, for an £85,000 APS allowance on top of her regular £20,000 annual ISA limit. Emma could invest up to £105,000 into her own ISAs in the current tax year, preserving the tax-free wrapper. She has 3 years from David's death (or 180 days after estate administration completes, whichever is later) to use this allowance. Non-spousal beneficiaries receive the ISA money but cannot inherit the tax-free status—the account simply becomes regular savings subject to normal tax rules.

Common Questions

"What happens to my ISA when I die?" When you die, your ISA becomes a "continuing ISA" that maintains its tax-free status for up to 3 years. The value forms part of your estate for Inheritance Tax purposes, though no Income Tax or Capital Gains Tax applies. Your ISA passes to beneficiaries named in your will or under intestacy rules.

"Can my spouse inherit my ISA's tax-free status?" Yes, your spouse or civil partner receives an Additional Permitted Subscription (APS) allowance equal to your ISA's value on death. This allows them to invest that amount in their own ISA while preserving the tax-free status, on top of their regular £20,000 annual allowance. They must use this within 3 years of your death.

"Do I need to include my ISA in my will?" Yes, you should include ISAs in your will as they form part of your estate. While they're tax-free during your lifetime, ISAs count toward your estate value for Inheritance Tax purposes. Naming specific beneficiaries ensures your ISA passes to your chosen recipients rather than following intestacy rules.

Common Misconceptions

Myth: ISAs are completely tax-free, including inheritance tax

Reality: While ISAs are free from income tax and capital gains tax during your lifetime, they count toward your estate value for Inheritance Tax purposes. If your total estate (including ISAs) exceeds £325,000, your beneficiaries may face a 40% inheritance tax charge on the excess—even though you paid no tax on the ISA growth while alive. ISAs have been heavily marketed as "tax-free" accounts for decades, leading many to assume this tax-free status extends to all taxes including IHT.

Myth: Only my spouse can inherit my ISA money

Reality: You can leave your ISA to anyone you choose in your will—children, friends, charities, or any other beneficiary. What IS spouse-specific is the Additional Permitted Subscription (APS), which allows your spouse or civil partner to preserve the tax-free wrapper by investing the ISA's value into their own ISA. Non-spousal beneficiaries receive the money but cannot maintain the tax-free ISA status.

  • Investment Portfolio: ISAs are a common tax-efficient wrapper for investment portfolios—your Investment Portfolio is the broader collection of stocks, bonds, and funds, while an ISA is the specific account that can hold these investments.
  • Stocks and Shares: One of the four main ISA types is the Stocks & Shares ISA, which holds equity investments—Stocks and Shares describes the asset type while ISA describes the tax wrapper.
  • Cash ISA: A specific type of ISA that works like a savings account but with tax-free interest, representing one of the four available ISA categories.
  • Stocks and Shares ISA: The tax-efficient wrapper specifically designed for equity investments, distinct from both Cash ISA and the general concept of stocks and shares.
  • Lifetime ISA: The newest ISA type (introduced April 2017) with unique features including a government bonus, age restrictions (18-40), and specific purposes (first home or retirement), with its own £4,000 annual limit within the overall £20,000 allowance.

Need Help with Your Will?

Planning how your ISA will pass to your loved ones is essential for your estate, especially if your ISAs could push your total assets over the Inheritance Tax threshold. Understanding ISA treatment ensures your beneficiaries receive maximum value.

Create your will with confidence using WUHLD's guided platform. For just £99.99, you'll get your complete, legally binding will plus three expert guides. Preview your will free before paying anything—no credit card required.

Legal Disclaimer:

This article provides general information only and does not constitute legal or financial advice. WUHLD is not a law firm and does not provide legal advice. Laws and guidance change and their application depends on your circumstances. For advice about your situation, consult a qualified solicitor or regulated professional. Unless stated otherwise, information relates to England and Wales.