Previously, they could inherit the ISA fund itself, but it would no longer be tax-free. As always with these announcements, though, the devil is in the detail, and this is no exception. Most importantly for clients, the mechanics of how this will be implemented will be quite straightforward. The surviving spouse will simply get an increased ISA allowance, and, happily, clients won't have to change their Wills in order for their spouse to benefit.
If an ISA holder's death occurs after 3 December 2014, their spouse/civil partner will get an ISA allowance equal in value to their deceased spouse's ISA fund to invest in their own ISA - on top of their own annual ISA limit. This extra allowance will be available to use from 6 April 2015.
The good news
It is the tax-free allowance which is transferable rather than the ISA itself, giving the surviving spouse greater control over their new investment. The survivor can choose to invest the funds in a Cash ISA, or in a Stocks and Shares ISA, or in a combination of these.
These changes shouldn't affect any estate planning already in place. ISA holders won't have to change their Wills for their spouses/civil partners to benefit, as it is the allowance which is transferred rather than the ISA itself. Otherwise, it would have proved untenable when a deceased's Will specified that assets were to be held on trust for their surviving spouse. But, given the flexibility of the new ISA transfer rules, the deceased's assets can be distributed under the terms of their existing Will with their spouse simply getting the benefit of the tax-free status of their ISA. The transferred allowance will remain tax-free in terms of income tax and capital gains tax within the ISA wrapper.
The bad news
The downside is that inheritance tax (IHT) may ultimately become payable on these ISA funds. When the ISA assets are inherited by the surviving spouse, initially the spousal exemption will apply. On the second death, however, 40% IHT could become payable on the 'double' ISA fund if the estate exceeds the available nil-rate band. (Up to £650,000 if there are two nil rate bands available on the second death.)
We think this is a really positive announcement. A number of our clients have accumulated substantial ISA funds over the years and the ability for a surviving spouse/civil partner to maintain the tax-efficient status is welcome and extremely practical. A lot of our clients rely on their ISA pots as a source of tax-free income so maintaining this at a time when pension income may be reduced on the death of a spouse/civil partner will be reassuring in many cases.
If you need advice on your ISA, please contact our Wealth Management team.