Is it possible to protect my ISAs from inheritance tax?

Given that pensions will be subject to the levy starting in April 2027, many investors and savers will be wondering if there is anything they can do to shield their ISAs from inheritance tax

We present the options that ISA clients have.

The inheritance tax (IHT) is one of the most despised taxes, and ISAs are among the most widely used savings and investment products.

Many ISA customers naturally wonder if it's possible to shield ISAs from the dreaded inheritance tax and transfer these tax-efficient vehicles to loved ones without their finances being negatively impacted by the tax collector.

The fact that pension pots, which are currently exempt from IHT, will be subject to the tax starting in April 2027 may have made the question more relevant.

Unfortunately, ISAs are not specifically exempt from IHT. There are, nevertheless, a few strategies to lower a possible inheritance tax bill or guarantee that the tax is not due on ISA funds upon your death.

Give your civil partner or spouse your ISA.

The best way to avoid paying income tax on your ISA or any other assets you own, if you have a spouse or civil partner, is to leave them your estate when you pass away.

"ISAs are subject to inheritance tax unless they are left to your spouse or civil partner, as there is no IHT payable when assets are passed to them upon your death," explains Shaun Moore, one of the wealth manager Quilter's tax and financial planning specialists.

Your spouse or civil partner will be able to continue to profit from any tax-free gains and income that may be generated in this situation, and the money will also be able to maintain its ISA status.

This is in addition to any contributions they wish to make using their own ISA allowance, which is currently £20,000 per tax year.

Determine whether an IHT liability exists.

It makes sense to determine if your ISA would be liable for IHT because you might discover that your assets and money are exempt from the tax. Just 5% of the wealthiest families are required to pay IHT.

Before IHT takes effect, everyone receives a "nil-rate band" for funds transferred to beneficiaries other than a spouse. Typically, people can transfer 325,000 to beneficiaries without submitting an IHT application.

Additionally, there is a 175,000 residence nil-rate band for people who leave their primary residence to a child or grandchild, who are considered "direct descendents." For some people, this means that a total of 500,000 can be left tax-free.

According to Moore, "if your spouse or civil partner dies before you, you can pass on IHT free up to 1 million because any unused nil-rate band can be transferred to you."

So, before you worry about protecting your ISA savings from the tax, you should figure out how much your estate is worth and, consequently, how much may be subject to IHT.

Before you pass away, give money to your loved ones.

There are several things you could think about if you're worried that your ISAs might be subject to IHT.

For example, it might be worthwhile to think about giving money to a loved one while you are still alive if you plan to leave them your savings after you die.

Moore tells the BFIA: "This can help lower the value of your estate and, consequently, any IHT bill, in addition to giving them financial support that you could see them enjoy.

He goes on to say: "You can give up to 3,000 IHT-free per year, or you can give as much as you like, but IHT will only consider it outside of your estate if you live for seven years after the gift.

Additionally, you can use extra money to make gifts. In order to distribute interest earned on a cash ISA or dividends or profits from a stocks and shares ISA, you must be able to demonstrate that this is income rather than capital. These presents must be "regular" and cannot have an impact on your quality of life.

According to Wealth Club's head of investment research, Jonathan Moyes, "We have observed an increasing trend among investors to gift surplus income, as this is IHT free and does not fall within the seven-year limit on gifts." This can be a useful strategy to reduce future IHT liabilities given the higher yields of today.

Moore goes on to say that a junior ISA can be a convenient location to deposit a gift for a child under the age of 18. "The junior ISA allowance is very generous and means you can contribute up to 9,000 per child each year," he explains. If you have grandchildren, you might want to think about giving them regular gifts to fund their JISAs.

Think about moving to AIM shares, but be aware that the relief will be lessened.

IHT-free investments in qualifying AIM shares have historically been a helpful strategy for investors looking to lower their tax obligations.

Tax relief will, however, be cut in half starting in April 2026, from 100% to 50%. This means that qualifying AIM shares will be subject to 20% inheritance tax instead of zero, which is still half of the full 40% IHT rate.

According to Moyes, tax breaks are still available (albeit at a reduced rate) because the government is eager to help fund small and medium-sized businesses in the UK.

"We frequently see retirees who have accumulated a sizable ISA portfolio and have other assets that put them over the inheritance tax threshold looking at AIM ISAs," he remarks. Investors in AIM can lower their inheritance tax liability while maintaining access to funds in case they require them later in retirement.

Moyes thinks that AIM portfolios will become more popular in the upcoming years due to the government's decision to make pensions subject to inheritance tax, even with the reduced tax relief.

But keep in mind that AIM shares are risky and should only be purchased by seasoned investors. In the end, Moore warns: "If the investments did not work out as planned, you might lose more money than it would cost to pay any IHT bill.

You have two options if you want to use AIM to lower your IHT bill: invest in your own AIM shares or pick a professionally managed portfolio.

Wealth Club has several AIM IHT ISAs available. Over the previous 12 months, the Octopus AIM IHT ISA and the Downing Estate Planning AIM ISA were the most popular managed AIM ISAs on Wealth Club.

Whereas Downing seeks to invest in unloved and underutilized opportunities, the Octopus portfolio is biased toward the biggest junior market companies.