Inheritance tax (IHT) is often called a voluntary tax because, with the right planning, many families can reduce or eliminate the bill. This guide covers everything you need to know about IHT in the UK and how to protect your family’s wealth.
What Is Inheritance Tax?
IHT is a tax on the estate of someone who has died. The estate includes property, money, possessions, and investments. It also applies to certain gifts given by the deceased within seven years of their death.
IHT is paid by the estate before assets are distributed to beneficiaries. In most cases, the executor handles payment.
IHT Rate
The standard IHT rate is 40% on the value of the estate above the nil-rate band. The rate is charged on the excess, not the entire estate.
If the deceased left at least 10% of their net estate to charity, the IHT rate reduces to 36% on the taxable portion.
Nil-Rate Band
Every individual has a nil-rate band, which is the amount of their estate that is taxed at 0%. For the 2024/25 tax year, this is £325,000 per person.
If a married couple or civil partners have not used their full nil-rate band, the unused portion can be transferred to the surviving partner. This means a couple can potentially shield up to £650,000 from IHT.
Residence Nil-Rate Band
An additional allowance is available when a main home is passed to a direct descendant (child, grandchild, or stepchild). For the 2024/25 tax year, this is £175,000 per person.
When combined with the standard nil-rate band, a single person can potentially shield £500,000 from IHT, and a couple can potentially shield up to £1,000,000.
The residence nil-rate band reduces by £1 for every £2 that the estate is worth above £2 million.
Married Couples and Civil Partners
Spouses and civil partners enjoy unlimited exemption from IHT. Transfers between them during lifetime or on death are completely exempt.
When the first partner dies, any unused nil-rate band and residence nil-rate band can be transferred to the surviving partner. This is one of the most powerful IHT planning tools available.
Gifts and the Seven-Year Rule
Gifts given by the deceased within seven years of their death may be added back to the estate for IHT purposes. This is known as a potentially exempt transfer.
- If the gift was made 7 or more years before death, it is fully exempt
- If made 3 to 7 years before death, taper relief applies, reducing the tax on a sliding scale
- If made within 3 years of death, the full 40% IHT rate applies
Annual Gift Exemption
Each person can give away £3,000 per year without it being added to their estate. If the full allowance is not used in one year, it can be carried forward to the next year only.
Small Gift Exemption
Gifts of up to £250 per person per year are exempt. This is in addition to the annual £3,000 allowance.
Other Gift Exemptions
- Wedding gifts — up to £5,000 to a child, £2,500 to a grandchild, £1,000 to anyone else
- Normal expenditure from income — regular gifts from surplus income are exempt
- Gifts for maintenance of family — supporting children, elderly relatives, or former spouses
- Charitable gifts — gifts to registered charities are fully exempt
Potentially Exempt Transfers
A gift to an individual is a potentially exempt transfer. If the donor survives for seven years, the gift is completely outside the estate. If they die within seven years, the gift is pulled back into the estate for IHT, subject to taper relief.
Trusts
Trusts can be used to manage IHT liability by removing assets from the estate. Common types include:
- Discretionary trusts — trustees decide who benefits and when
- Interest in possession trusts — beneficiaries receive income from the trust
- Bare trusts — beneficiaries have an immediate right to capital
Trusts are complex and the rules change frequently. Professional advice is strongly recommended before setting up a trust.
Life Insurance in Trust
A life insurance policy can be written in trust. This means the payout goes directly to the named beneficiaries rather than forming part of the estate. The proceeds are therefore outside the scope of IHT.
This is a simple and effective way to provide funds to cover an IHT liability without increasing the estate’s value.
Ways to Reduce Your IHT Bill
1. Give Gifts Within Allowances
Use your annual £3,000 exemption, small gift exemptions, and wedding gift allowances. These gifts are immediately outside your estate if you survive seven years.
2. Use Trusts for Complex Estates
Trusts can remove assets from your estate while retaining some control. Seek professional advice on the best trust structure for your situation.
3. Spend Your Wealth
The simplest way to reduce IHT is to spend your money. While this sounds obvious, many people focus on accumulation and forget that enjoying your wealth is an option.
4. Life Insurance in Trust
Take out a life insurance policy in trust to cover the expected IHT liability. This provides liquidity to pay the tax bill without forcing the sale of assets.
5. Charitable Donations
Leaving at least 10% of your net estate to charity reduces the IHT rate from 40% to 36%. This can actually result in a lower overall tax bill even after accounting for the charitable gift.
6. Use Your Nil-Rate Bands
Make sure your will is structured to maximise use of both nil-rate bands. This is particularly important for married couples.
Worked Example
James dies with an estate worth £750,000. His will leaves everything to his children.
Step 1: Apply nil-rate bands
- Nil-rate band: £325,000
- Residence nil-rate band: £175,000
- Total exempt amount: £500,000
Step 2: Calculate taxable estate
£750,000 - £500,000 = £250,000
Step 3: Calculate IHT
£250,000 x 40% = £100,000 IHT
Adding lifetime gifts
If James gave his daughter £50,000 two years before his death, this is a potentially exempt transfer that fails because he died within seven years. The £50,000 is added to the estate:
£750,000 + £50,000 = £800,000 £800,000 - £500,000 = £300,000 £300,000 x 40% = £120,000 IHT
If the £50,000 gift had been made eight years earlier, it would have been fully exempt and the IHT would remain at £100,000.
Practical Tips
- Write a will — dying without one means the estate is distributed by intestacy rules, which may not reflect your wishes
- Maximise nil-rate bands — structure your will to use both the standard and residence nil-rate bands
- Give gifts early — the earlier you give gifts, the more likely they are to fall outside the seven-year window
- Use trusts wisely — trusts can be powerful but are complex, get professional advice
- Consider life insurance — write a policy in trust to provide funds for the IHT bill
- Review regularly — IHT rules change, review your plans every few years
- Seek professional advice — IHT planning is complex, consult a qualified financial adviser or solicitor