Inheritance Tax Explained: Who Pays, What Rate & How to Minimise It

Q: At what threshold does inheritance tax kick in?

The standard nil-rate band for inheritance tax is £325,000 per person. Estates below this value pay no IHT. If you are passing your main home to direct descendants (children or grandchildren), you may also qualify for the Residence Nil-Rate Band of £175,000 — bringing the total effective threshold to £500,000 for a single person. Married couples and civil partners can combine their allowances, potentially shielding up to £1,000,000 from IHT when the second partner dies.

Q: Can I give money away to avoid inheritance tax?

Gifts made during your lifetime can reduce your estate for IHT purposes, but most fall under the seven-year rule: gifts must survive at least seven years before they are fully outside your estate. Gifts made 0–3 years before death attract IHT at 40%; gifts made 3–7 years qualify for taper relief (40% reducing to 8%). Certain gifts are always exempt: the annual £3,000 exemption, small gifts up to £250 per person, wedding gifts up to £5,000 per child, and gifts to charity.

Q: Does a pension form part of my estate for inheritance tax?

Currently (until April 2027 under proposed legislation), most defined contribution pensions sit outside your estate for IHT purposes. This makes pension pots an exceptionally tax-efficient way to pass wealth to beneficiaries — unused pension funds can be inherited free of IHT, though beneficiaries may pay income tax on withdrawals if the pension owner died after age 75. Note: legislation proposed in the Autumn 2024 Budget would bring unspent pension pots into the IHT estate from April 2027, so this position may change.

Inheritance tax affects a growing number of estates as property values rise. Here is a complete explanation of the thresholds, rates, exemptions and planning strategies for 2025-26.

What Is Inheritance Tax?

Inheritance Tax (IHT) is charged on the estate of someone who has died — their total assets (property, cash, investments, personal possessions) minus debts and funeral costs. The rate is 40% on the portion of the estate above the available nil-rate bands. IHT is paid by the estate before assets are distributed to beneficiaries; it is typically funded by selling assets within the estate.

Despite widespread perception, IHT affects a relatively small proportion of estates — HMRC data shows roughly 4–5% of UK deaths result in an IHT charge. However, rising property values mean the threshold is catching more middle-income families than originally intended when the nil-rate band was frozen at £325,000 in 2009.

The Nil-Rate Band: £325,000

Every individual has a nil-rate band of £325,000. Estates up to this value pay zero IHT. Above £325,000, the standard rate of 40% applies. The nil-rate band has been frozen at this level since 2009 and is set to remain frozen until April 2030 under current policy — a stealth increase in effective IHT liability as asset values rise.

The Residence Nil-Rate Band: Additional £175,000

Since 2017, an additional Residence Nil-Rate Band (RNRB) is available when the deceased's main home is left to direct descendants — children, stepchildren, grandchildren or adopted children. In 2025-26, the RNRB is £175,000.

Combined with the standard nil-rate band, a single person leaving their home to children has a total IHT threshold of £325,000 + £175,000 = £500,000. Estates above £2 million see the RNRB tapered away at £1 for every £2 of excess, disappearing completely at £2.35 million. The RNRB also applies proportionally if a smaller home is left and the remainder of the estate goes to direct descendants.

Married Couples: Combining Allowances

Assets passing between married couples or civil partners are exempt from IHT — there is no charge when the first spouse dies. The key benefit of marriage for IHT purposes is the ability to transfer unused nil-rate band. When the first spouse dies without using their full nil-rate band, the unused portion transfers to the surviving spouse. On second death, the estate can claim up to two full nil-rate bands — up to £650,000 in standard allowances, or up to £1,000,000 combined (2 × £325,000 + 2 × £175,000 RNRB) when the family home passes to children.

Worked Examples

Single Person, £700,000 Estate (with home passed to children)

Standard nil-rate band: £325,000
Residence nil-rate band: £175,000
Total threshold: £500,000
Taxable estate: £700,000 − £500,000 = £200,000
IHT at 40%: £80,000

Married Couple, £1.4 Million Estate (home to children, second death)

Combined nil-rate bands: £650,000
Combined residence nil-rate bands: £350,000
Total threshold: £1,000,000
Taxable estate: £1,400,000 − £1,000,000 = £400,000
IHT at 40%: £160,000

Single Person, £500,000 Estate (no home, or not left to direct descendants)

Only the standard nil-rate band applies: £325,000
Taxable estate: £500,000 − £325,000 = £175,000
IHT at 40%: £70,000

Legitimate Ways to Reduce Your IHT Liability

Gifts and the Seven-Year Rule

Gifts made more than seven years before death are outside the estate completely. Between three and seven years before death, taper relief reduces the IHT rate: 32% at 3–4 years, 24% at 4–5 years, 16% at 5–6 years, 8% at 6–7 years. The gifts must be "potentially exempt transfers" — outright gifts to individuals with no strings attached.

Annual Exemptions

You can give away £3,000 per year free of IHT. If you did not use your allowance last year, you can carry it forward — giving up to £6,000 in a single year. Additional smaller exemptions: wedding gifts up to £5,000 to a child, £2,500 to a grandchild, £1,000 to anyone; and small gifts of up to £250 per person per year.

Pensions

Defined contribution pension pots currently (pending 2027 legislation) sit outside the estate. Leaving a pension to beneficiaries is one of the most efficient ways to pass wealth without IHT. Beneficiaries pay income tax on drawdowns if the owner died after 75, but pay no income tax if the owner died before 75.

Charitable Donations

Gifts to registered charities are IHT-exempt. If you leave at least 10% of the taxable estate to charity, the IHT rate on the remainder drops from 40% to 36% — a meaningful saving that can also reflect your values.

Life Insurance in Trust

A whole-of-life insurance policy written in trust pays out on death outside the estate, providing immediate cash to pay the IHT bill without waiting for probate. The policy itself does not form part of the estate as long as it is correctly structured in trust.

Frequently Asked Questions

At what threshold does inheritance tax kick in?

The standard nil-rate band is £325,000. If you are leaving your main home to direct descendants, an additional £175,000 RNRB applies — giving a total threshold of £500,000 per person, or £1,000,000 for married couples on second death.

Can I give money away to avoid inheritance tax?

Gifts must survive seven years before they fully leave your estate. Partial relief applies from 3 years. The annual £3,000 exemption, small gift exemptions and charitable donations are always IHT-free regardless of the seven-year rule.

Does a pension form part of my estate for inheritance tax?

Currently, most defined contribution pensions are outside your estate for IHT. Proposed legislation from April 2027 would bring unspent pension pots into the IHT estate — so this position may change. Take advice before making decisions based on current pension IHT treatment.