The additional permitted subscription (APS) can be very useful when doing financial planning for a widow or widower, as Jessica Franks, Head of Tax, Octopus Investments, explains.
Since April 2015, surviving spouses of ISA investors have been able to make additional ISA subscriptions over and above their own ISA allowance, by effectively being given a one-off incremental ISA allowance equivalent to the value of their spouse’s ISA when they died.
This extra ISA allowance is available to a surviving spouse who inherits their spouse’s ISA and to one who doesn’t. For example, if the assets from within an ISA are left to the children, the surviving spouse can choose to invest into an ISA using any source of funds up to the value of their spouse’s ISAs when they died. This is on top of their own £20,000 annual ISA subscription allowance.
One area where the APS can prove useful is estate planning. Often the spouse who has died was the one who looked after the finances. The surviving spouse will now need to make a new plan.
Consider the case of a widow who is sorting out her late husband’s estate. To keep things simple, imagine the husband left everything to her. The house, his pension, and all his other investments, including a Stocks and Shares ISA he built up that’s now worth £100,000.
As a result, the surviving spouse has an APS of £100,000. In other words, she can put £100,000 into an ISA over and above her own £20,000 annual allowance (note that this would be the case even if the husband had left his ISA to someone else).
Let’s now assume that the surviving spouse doesn’t really need the ISA assets. She has enough to cover her needs without them. She would like to find a way to pass that wealth to their son. She could make a gift of the assets. But because her husband’s death was unexpected, and because she herself is of advancing years, she is concerned she may not survive the seven years she would need to in order to avoid leaving their son with an inheritance tax bill.
Estate planning within the ISA wrapper
Despite the generous lifetime benefits an ISA offers, any new funds invested in an ISA will be subject to inheritance tax when the surviving spouse herself passes away, unless planning is done to address this. Based on its current value, that would mean an inheritance tax bill of £40,000 on the ISA pot alone.
One option could be to open a type of AIM Inheritance Tax ISA that is specifically managed to invest into companies that qualify for Business Property Relief (BPR).
BPR is a longstanding relief from inheritance tax designed to be an incentive to take on the risk of investing in unquoted or Alternative Investment Market (AIM)-listed businesses that meet certain qualifying criteria. APS rules mean the surviving spouse could make a one-off new investment in such an ISA up to £100,000 (the value of her late husband’s ISA pot). She would also be able to make new annual subscriptions in the usual way of up to £20,000 each year, or to transfer over any ISAs held in her own name if she wanted to.
In this particular scenario, an AIM Inheritance Tax ISA might be a good option because the client does not need the assets, and she may therefore be happy to keep that capital invested in the market. By holding such an investment, she would benefit from tax-free growth and dividends, a benefit that would be lost if she doesn’t use the APS.
Because shares in certain AIM listed companies can qualify for Business Property Relief, the AIM Inheritance Tax ISA has a significant additional benefit for her. After she has been invested for two years, the shares in her portfolio will become zero-rated for inheritance tax. After two years, she would be able to continue to hold it knowing that when she passed away, the ISA could pass to her son without triggering an inheritance tax bill. By way of comparison, if she gifted the assets in her late husband’s ISA to her son straightaway, she would need to survive seven years for the gift to become completely free from inheritance tax.
What are the risks?
There are risks to consider.
The value of an AIM Inheritance Tax ISA, and any income from it, can fall or rise, and investors may not get back the full amount they put in. So while there is the potential for that £100,000 to grow, there’s also the potential for it to lose value. An AIM Inheritance Tax ISA is likely to be higher risk than more mainstream stocks and shares ISAs.
It’s also important clients are aware that when an investor dies holding an AIM Inheritance Tax ISA and the estate claims BPR, HMRC will make an assessment of each company in the portfolio as to whether it qualifies for the relief. Advance assurance is not available. Tax treatment depends on individual circumstances and could change in future. Tax reliefs depend on portfolio companies maintaining their qualifying status.
In addition, the share price of AIM-listed companies can fall or rise by more than those listed on the main market of the London Stock Exchange. They may also be harder to sell.
It’s important to balance these risks against the benefits before recommending this type of investment.
Other estate planning scenarios you may find interesting
BPR can form part of a client’s estate planning in a range of different situations.
Clients concerned about making large gifts, for example, might be more receptive to discussing an investment that stays in their name. BPR can also be a particularly useful option when there is a power of attorney in place, for clients who have sold a business in the last three years, and for elderly clients who are concerned about whether they will live for seven years.
Take a look at the different BPR planning scenarios on the Octopus Investments website.
