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Inheritance Tax Explained — Thresholds, Exemptions and How to Reduce Your Bill

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Inheritance tax (IHT) is one of the most discussed — and most misunderstood — taxes in the UK. At 40%, it's a significant rate, yet most estates never pay it at all. Understanding exactly when IHT applies, what's exempt, and how to plan around it can make a substantial difference to what your family ultimately receives.

What is inheritance tax?

Inheritance tax is a tax on the estate (the property, money and possessions) of someone who has died. HMRC collects it before beneficiaries receive anything. It's technically the estate — not the recipients — that pays the bill, and it must usually be settled within six months of the date of death.

Around 4–5% of UK deaths result in an IHT charge in a typical year. That figure is rising, however, as rising property values push more estates over the threshold while the thresholds themselves remain frozen.

The inheritance tax threshold (nil-rate band)

The first £325,000 of any estate is taxed at 0% — this is called the nil-rate band (NRB). Everything above it is taxed at 40%. The nil-rate band has been frozen at £325,000 since 2009 and is set to remain there until at least 2030.

The residence nil-rate band

An additional allowance — the residence nil-rate band (RNRB) — applies when a main home is passed to direct descendants (children, grandchildren, stepchildren, adopted children). This adds a further £175,000 to the threshold, giving a potential total of £500,000 per person.

IHT thresholds at a glance

Situation	Effective threshold
Single person, no property passed to descendants	£325,000
Single person, home passed to direct descendants	£500,000
Married couple / civil partners, no property to descendants	£650,000
Married couple / civil partners, home to direct descendants	£1,000,000

The combined allowance for couples works because any unused nil-rate band can be transferred to a surviving spouse or civil partner when the second person dies.

How the tax is calculated

Once you know the applicable threshold, the calculation is straightforward:

• Add up the total value of the estate (assets minus debts and funeral costs)
• Subtract the nil-rate band (and RNRB if applicable)
• Charge 40% on the remainder

Example: A single person with no children leaves an estate worth £600,000. Their nil-rate band is £325,000. The taxable portion is £275,000. IHT due = £275,000 × 40% = £110,000.

Example 2: The same person owns a home they plan to leave to their children. The RNRB brings the threshold up to £500,000. The taxable portion is now £100,000. IHT due = £100,000 × 40% = £40,000.

Spouse and civil partner exemption

Transfers between UK-domiciled spouses and civil partners are completely exempt from inheritance tax — there is no limit on the amount. This means that in most cases, no IHT is due when the first partner dies; it becomes relevant only when the surviving partner's estate is passed on.

Gifts and the 7-year rule

Giving money or assets away before death is one of the most common IHT planning strategies. The rules work as follows:

• Gifts made more than 7 years before death fall outside the estate entirely and are not taxed.
• Gifts made within 7 years are known as potentially exempt transfers (PETs). If the donor dies within 7 years, the gift is added back into the estate for IHT purposes.
• Gifts made between 3 and 7 years before death may benefit from taper relief, which reduces the IHT rate on those gifts.

Taper relief rates

Years between gift and death	IHT rate on the gift
0–3 years	40%
3–4 years	32%
4–5 years	24%
5–6 years	16%
6–7 years	8%
Over 7 years	0%

Annual gift exemptions

You don't have to wait 7 years for small gifts to become exempt. HMRC allows several annual exemptions that fall outside IHT immediately:

Exemption	Amount
Annual gift allowance (per person, per year)	£3,000
Small gifts to any individual	£250 per person
Wedding gift — from parent	£5,000
Wedding gift — from grandparent	£2,500
Wedding gift — from anyone else	£1,000
Gifts from normal expenditure out of income	Unlimited (conditions apply)

The annual £3,000 allowance can be carried forward one year if unused, potentially allowing a £6,000 gift in a single year. The "normal expenditure out of income" exemption is valuable for those with surplus income — regular gifts (such as paying a grandchild's school fees or a standing order to family) can be exempt if they come from income rather than capital and don't reduce your own standard of living.

Charitable donations

Gifts to UK-registered charities in your will are fully exempt from IHT. Better still, if you leave at least 10% of your net estate to charity, the IHT rate on the remainder drops from 40% to 36%. This can make charitable giving in a will surprisingly tax-efficient for larger estates.

Business and agricultural property relief

Business Property Relief (BPR) and Agricultural Property Relief (APR) can significantly reduce or eliminate IHT on qualifying assets:

• BPR at 100%: Unlisted shares (including AIM shares held for 2+ years), interests in a business partnership, sole trader businesses.
• BPR at 50%: Shares in a quoted controlling company, certain land and buildings used in a business.
• APR at 100% or 50%: Agricultural land and farmhouses actively farmed, subject to conditions.

These reliefs are generous but the rules are complex. Professional advice is strongly recommended before relying on them for planning purposes.

Pensions and inheritance tax

Under current rules, pension pots are generally outside your estate for IHT purposes — one reason pensions are often described as one of the most tax-efficient ways to pass on wealth. However, the government announced in the Autumn 2024 Budget that inherited pension pots will become subject to IHT from April 2027. This is a significant change that affects estate planning for anyone relying on a pension to pass wealth to the next generation.

Trusts

Placing assets in a trust can remove them from your estate, but trusts have their own tax rules and are not a straightforward IHT solution. There are several types of trust (bare trusts, discretionary trusts, interest in possession trusts), each with different IHT, income tax and capital gains tax consequences. A trust should be set up with professional legal and financial advice.

Life insurance written in trust

A life insurance policy written in trust pays out to the trust beneficiaries rather than your estate, so the payout falls outside your estate for IHT purposes. This is a straightforward and relatively low-cost way to ensure your family has funds available to pay an IHT bill without waiting for probate to be granted — which can take months.

How to pay inheritance tax

IHT must be paid to HMRC within 6 months of the date of death. After that, interest accrues. Probate (the legal process of administering the estate) typically cannot be granted until at least some IHT is paid — creating a catch-22 for estates where the wealth is illiquid (such as property). Options include:

• Paying from available cash in the estate
• A bank loan against the estate
• For property, IHT can be paid in annual instalments over 10 years (interest applies)
• Direct payment from a bank or building society account in the deceased's name, using the HMRC "direct payment" scheme before probate

Key steps to reduce an IHT bill

1. Use your annual gift allowances every year — £3,000 per person, carried forward one year if unused.
2. Make larger gifts early — the 7-year clock starts ticking from the date of the gift, not when you plan it.
3. Leave assets to a spouse or civil partner first — this defers the IHT bill and transfers any unused nil-rate band.
4. Write your life insurance in trust — keeps the payout out of your estate and speeds up payment to beneficiaries.
5. Consider charitable bequests — leaving 10%+ of your estate to charity reduces the rate from 40% to 36%.
6. Review pension nominations — especially ahead of the April 2027 rule change.
7. Seek professional advice — for larger or more complex estates, a specialist solicitor or IFA can tailor a plan that's legal and effective.