ISAs ‘not always tax-free’ as adviser warns of inheritance tax trap

ISAs have long been promoted as straightforward and tax-efficient savings, but many are unaware of the inheritance tax implications upon death – and the consequences are proving costly

Millions of savers may be harbouring an expensive misconception about ISAs, an expert has cautioned. Many assume they are entirely tax-free when actually they could face a substantial bill from HMRC later on.

ISAs have historically been promoted as amongst the most straightforward and efficient savings vehicles, enabling savers to accumulate wealth without paying tax. But one expert cautions that this “tax-free” description is frequently misinterpreted – especially regarding what occurs upon death.

The concern is inheritance tax. Presently levied at 40 percent on estates exceeding £325,000, the threshold has remained frozen for years, steadily pulling increasing numbers of families into the tax net. Significantly, ISA savings are counted as part of the estate. That means a lifetime of prudent saving, frequently accumulated with discipline across decades, could still be vulnerable to a considerable tax bill.

Joe Farmer, an Independent Financial Adviser and co-founder at The Retirement Studio, said many have no idea they have to pay inheritance tax on their ISA savings.

He added: “I speak to clients every day who believe ISAs are completely tax-free, full stop. They’re genuinely shocked when I explain that on death, ISAs form part of the estate and can be subject to inheritance tax.”

He said the magnitude of the problem was frequently underestimated, even among those who regarded themselves as financially astute.

Mr Farmer continued: “I saw a client just last week with an ISA worth over £300,000. That alone nearly takes them to the inheritance tax threshold, before you even consider their home or any other assets.”

For many, the issue lies not in the act of saving itself – but in what hasn’t been considered further down the line.

He said: “This is the part most people haven’t thought about. They’ve done the right thing by saving into ISAs year after year, but they haven’t considered what happens to that money when they pass away.”

The repercussions stretch far beyond tax bills. Mr Farmer warned that ISA funds were frequently tied up in probate alongside the remainder of the estate, leaving families unable to get their hands on the money precisely when they needed it most.

He added: “I deal with bereavement cases and I regularly see ISA funds tied up in probate for months, sometimes years.”

For a product so heavily promoted as tax-free, he believes the messaging has created a deeply concerning gap in public understanding.

Mr Farmer added: “It’s tax-efficient while you’re alive, but that doesn’t mean it’s free from inheritance tax.”

He noted that the problem is frequently made worse by poor advice and a lack of forward planning.

He continued: “A lot of this comes down to structure being overlooked. Advisers focus on performance and returns, but not enough on what happens later. I always say to clients that structure is just as important as performance. There’s no point building a large ISA pot if a significant portion could be lost to tax or delayed in probate.”

With potential alterations to pensions from 2027, which could see them drawn into the inheritance tax net, the issue is only set to intensify.