Inheritance Tax Explained

Inheritance tax (IHT) is a tax on what you leave behind. With the tax-free thresholds frozen while house prices and savings have risen, more families are being drawn into it than ever. Understanding the basics is the first step to planning around it.

The basics: rate and thresholds

Inheritance tax is charged at 40% on the value of your estate above your tax-free allowances. Everything below those allowances is tax-free, and the rate drops to 36% if you leave at least 10% of your net estate to charity.

The two main allowances are:

• The nil-rate band — £325,000. Everyone gets this. No inheritance tax is due on the first £325,000 of your estate.
• The residence nil-rate band — up to £175,000. An extra allowance when you leave your main home to direct descendants (children, grandchildren and their families).

Both allowances are frozen until April 2031, which means more estates will exceed them over time as asset values rise.

Married couples and civil partners

Anything you leave to a UK spouse or civil partner is exempt from inheritance tax. On top of that, any allowances your partner doesn't use pass to you. Combined, a married couple or civil partnership can potentially pass on up to £1 million tax-free once both nil-rate bands and both residence bands are counted.

Note that the residence band is gradually withdrawn for larger estates — it tapers away by £1 for every £2 your estate is worth over £2 million, so the largest estates lose it altogether.

How inheritance tax is calculated — a worked example

Suppose a widow dies leaving an estate of £900,000, including the family home, which passes to her children. She inherited her late husband's unused allowances, so she has a £650,000 nil-rate band and a £350,000 residence nil-rate band available — £1 million in total.

• Estate: £900,000
• Tax-free allowances: £1,000,000
• Taxable amount: £0 — the estate is within the allowances, so no inheritance tax is due.

Now suppose the estate is £1,300,000 instead. The first £1,000,000 is covered by the allowances, leaving £300,000 taxable. At 40%, that's an inheritance tax bill of £120,000 — payable before the children can inherit the home. This is the gap that lifetime planning and life cover written in trust are designed to close.

Giving money away

Gifts can reduce your estate, but the rules matter:

• The seven-year rule: most gifts fall fully outside your estate only if you live for seven years after making them. Die within that window and they may be taxed, on a sliding scale (taper relief).
• Annual exemption: you can give away £3,000 each tax year free of inheritance tax, plus small gifts of up to £250 per person.
• Gifts from income: regular gifts made out of your surplus income — not your capital — can be immediately exempt if they don't affect your standard of living.

Gifting is one of the most effective levers, but the timing rules are easy to get wrong. Our guide to inheritance tax and gifting covers the seven-year rule, taper relief and the common traps in full.

Other ways to reduce the bill

• Leave it to your spouse or civil partner. Anything passing between UK spouses or civil partners is exempt, and unused allowances transfer to the survivor.
• Give to charity. Gifts to registered charities are exempt, and leaving 10% or more of your net estate cuts the rate on the rest from 40% to 36%.
• Use trusts. Putting assets — or a life insurance policy in trust — can move value outside your estate and speed up payment to your family.
• Business and agricultural relief. Qualifying business and farming assets can attract relief, though recent reforms have tightened the rules — take specialist advice.

When and how is inheritance tax paid?

Inheritance tax is normally due by the end of the sixth month after death, and usually has to be paid before probate is granted — which is what creates the cash-flow problem for families. The tax on a home or other property can be spread over ten annual instalments, but the rest typically needs settling up front, often before the estate's assets can be sold or released. That's why having accessible, tax-free funds in place matters.

A change to be aware of: pensions from April 2027

From 6 April 2027, most unused pension funds will be counted as part of your estate for inheritance tax. This is a significant change that could pull many more families into paying. We cover it in detail in our guide to pensions and inheritance tax.

How protection helps

You can't always avoid an inheritance tax bill — but you can make sure your family has the cash to pay it without selling the home. A whole-of-life policy written in trust provides a tax-free lump sum on death, held outside your estate, that can be used to settle the bill. An adviser can size this against your likely liability.

This guide is general information, not personal tax, financial or legal advice. Inheritance tax rules are complex and depend on your circumstances, which may change. Figures are based on current UK rules. Speak to a qualified adviser for advice tailored to you.