What Is Inheritance Tax?
Inheritance tax (IHT) is a tax on the estate (property, money and possessions) of someone who has died. HMRC administers IHT in the UK, and it is currently charged at 40% on the value of an estate above the applicable threshold. A reduced rate of 36% applies if 10% or more of the net estate is left to qualifying charities.
Despite frequent media coverage, IHT affects a relatively small proportion of estates. HMRC statistics show that roughly 4% of deaths result in an IHT charge. However, because the nil-rate band has been frozen at £325,000 since 2009 — and is now frozen until at least 2030 — rising property values mean an increasing number of families are crossing the threshold each year. In 2023/24, HMRC collected a record £7.5 billion in inheritance tax receipts.
Understanding the rules thoroughly gives you the best chance of arranging your affairs efficiently, making appropriate gifts during your lifetime, and ensuring your loved ones receive the maximum benefit from your estate.
The Nil-Rate Band (NRB) Explained
Every individual has a nil-rate band (NRB) of £325,000. This is the threshold below which no IHT is charged. Any part of an estate above this amount is taxed at 40% (or 36% with charitable donation).
The NRB is transferable between spouses and civil partners. When the first spouse dies, if they do not use their full NRB (for example, because they leave everything to their surviving spouse), the unused percentage transfers to the surviving spouse. This means a couple can effectively have a combined NRB of up to £650,000.
Residence Nil-Rate Band (RNRB)
The residence nil-rate band provides an additional allowance of £175,000 per person when a main residence is passed to direct descendants (children, stepchildren, adopted children, foster children, or grandchildren). Like the standard NRB, it is also transferable between spouses.
This means a married couple who own a home and leave it to their children can potentially pass up to £1,000,000 completely free of IHT (£325,000 NRB + £175,000 RNRB for each spouse = £500,000 each, doubled to £1,000,000 for a couple).
RNRB Taper for Larger Estates
The RNRB is reduced by £1 for every £2 that the net estate exceeds £2,000,000. This means the RNRB is entirely eliminated for estates worth more than £2,350,000 per person (or £2,700,000 per couple). Estate planning strategies such as charitable legacies can be used to bring the estate below the £2 million threshold and preserve the RNRB.
| Situation | Available Allowance | Potential Tax-Free Amount |
|---|---|---|
| Single person, no property left to descendants | NRB: £325,000 | £325,000 |
| Single person, leaving main home to children | NRB + RNRB: £325,000 + £175,000 | £500,000 |
| Married couple, no RNRB | Combined NRB: £650,000 | £650,000 |
| Married couple, leaving home to children | NRB + RNRB both transferred | £1,000,000 |
Gifts and the 7-Year Rule
One of the most powerful IHT planning tools is making gifts during your lifetime. Gifts that are not immediately exempt (see below) are treated as Potentially Exempt Transfers (PETs). If you survive for seven years after making the gift, it falls completely outside your estate. If you die within seven years, the gift may be subject to IHT, but taper relief reduces the rate payable depending on how long ago the gift was made.
Taper Relief on Gifts (PETs)
Taper relief applies to gifts made between 3 and 7 years before death. Note: taper relief reduces the tax payable, not the value of the gift. It only kicks in when the gift value exceeds the available nil-rate band at the time of death.
Exempt Gifts
Certain gifts are immediately exempt from IHT and do not require you to survive seven years. These include:
| Exemption | Amount | Notes |
|---|---|---|
| Annual exemption | £3,000 per year | Unused allowance carries forward one year only |
| Small gifts exemption | £250 per person per year | Can give £250 to unlimited number of different people; cannot combine with annual exemption for same person |
| Wedding/civil partnership gift — child | Up to £5,000 | Must be made on or shortly before the wedding |
| Wedding/civil partnership gift — grandchild | Up to £2,500 | As above |
| Wedding/civil partnership gift — anyone else | Up to £1,000 | As above |
| Normal expenditure out of income | Unlimited | Must be from surplus income (not capital), habitual, and leave giver with adequate income for normal lifestyle |
| Gifts to spouse/civil partner | Unlimited | Fully exempt between UK-domiciled couples |
| Gifts to registered charities | Unlimited | Also reduces IHT rate to 36% if 10%+ of net estate donated |
| Gifts to UK political parties | Unlimited | Must meet qualifying conditions |
| Gifts to national institutions | Unlimited | Museums, universities, National Trust, etc. |
Business Property Relief (BPR) and Agricultural Property Relief (APR)
Business Property Relief (BPR)
BPR is one of the most significant IHT reliefs available, providing 100% or 50% relief on qualifying business assets owned for at least two years before death:
- 100% relief: A sole trade business or partnership interest; unquoted shares (including AIM-listed shares after two years of ownership); shares in an unquoted company where the deceased had control.
- 50% relief: Shares in a quoted company where the deceased had voting control; land, buildings, or machinery owned personally but used by the deceased's business or partnership.
BPR does not apply to businesses that mainly deal in land, buildings, securities, or investments — so a property investment company would generally not qualify. The two-year ownership rule is strict: assets acquired less than two years before death do not qualify.
Agricultural Property Relief (APR)
APR provides relief of up to 100% on the agricultural value of qualifying farmland and farm buildings. The property must be agricultural land or pasture in the UK, Channel Islands, or Isle of Man, and it must have been owned and occupied for agricultural purposes for at least two years (if occupied by the owner) or seven years (if tenanted). APR covers the agricultural value only; if the property has development value, APR does not cover that element — though BPR may in some cases.
Trusts and Inheritance Tax
Trusts are a common estate planning tool that can help manage IHT, though the rules are complex and have been tightened considerably since 2006. The main types relevant to IHT are:
Bare Trust
Assets in a bare trust are treated as owned by the beneficiary (the person they are held for). Gifts into a bare trust are PETs — exempt after seven years. Bare trusts are commonly used for children's savings.
Discretionary Trust
Assets in a discretionary trust enter a special IHT regime. A gift into a discretionary trust is a chargeable lifetime transfer (CLT) — taxed at 20% immediately if it exceeds the nil-rate band (with the remaining 20% due if the settlor dies within 7 years). Discretionary trusts also face a 10-year anniversary charge (currently up to 6% of the trust's value above the NRB) and an exit charge when assets leave the trust.
Interest in Possession Trust (IPDI)
An immediate post-death interest (IPDI) trust created on death — for example, leaving a property to a surviving spouse for life — is treated as part of the surviving spouse's estate for IHT purposes. This can be useful for second marriages where you want to protect children from a first marriage.
IHT and Pensions
Defined contribution (DC) pension pots are generally held in trust by the pension scheme and are outside your estate for IHT purposes. This makes unspent pension savings highly tax-efficient to pass on, particularly if the beneficiary is a basic-rate taxpayer who will draw the pension gradually. However, the government has proposed bringing unused pension funds into the estate for IHT purposes from April 2027. If this change proceeds, careful pension planning will become even more important.
ISAs and Inheritance Tax
Despite their many tax advantages, ISAs do not reduce your estate for IHT purposes. The full value of your ISA forms part of your taxable estate on death. However, there is one important exception: the Additional Permitted Subscription (APS) rule allows a surviving spouse or civil partner to inherit the deceased's ISA and maintain its tax-free status. The APS is equal to the value of the deceased's ISA at death. The surviving spouse can subscribe this amount to their own ISA in addition to their normal annual allowance. This preserves the tax-free income and growth advantage, but does not remove the ISA from the estate for IHT purposes.
How to Reduce Your Inheritance Tax Bill
There are several legitimate strategies for reducing IHT:
1. Make Gifts Early
The seven-year clock starts when you make the gift, so starting early gives gifts the best chance of becoming fully exempt. Use annual exemptions (£3,000/year), small gifts (£250 per person), and consider larger PETs if you can afford to give away assets and survive seven years.
2. Use Trusts Strategically
Discretionary trusts allow you to provide for children or grandchildren without the assets forming part of their estate — useful if they are not yet financially responsible or if you want the flexibility to change beneficiaries.
3. Whole of Life Insurance Written in Trust
A whole of life insurance policy written in trust pays out directly to beneficiaries on death without forming part of the estate. The proceeds can be used to pay the IHT bill, preventing the need to sell family assets like a home.
4. Leave Money to Charity
Charitable legacies are fully IHT-exempt, and if you leave at least 10% of your net estate to charity, the IHT rate on the remainder reduces from 40% to 36%.
5. Utilise Business and Agricultural Reliefs
If you own a business or farmland, BPR and APR can eliminate IHT on those assets entirely. AIM shares held for two or more years also qualify for 100% BPR.
6. Spend and Enjoy Your Wealth
Spending money on holidays, home improvements, or experiences reduces your estate naturally. Normal expenditure out of income is immediately exempt. Making gifts from surplus income — if you have more income than you need for your normal standard of living — is a powerful and underused relief.
IHT Forms and Deadlines
When someone dies and their estate is potentially liable for IHT, the personal representatives (executors) must:
- Complete IHT400 (the main IHT return) for taxable estates, along with relevant supplementary schedules.
- For simpler estates below the IHT threshold, the shorter IHT205 (or online equivalent) may be used.
- Pay any IHT due within six months from the end of the month of death. Interest accrues on late payments at HMRC's official rate.
- Note that IHT must often be paid before probate is granted — a "catch-22" that can create cash flow problems. HMRC allows IHT on property to be paid in annual instalments over 10 years, though interest applies.