Understanding Inheritance Tax: Thresholds, rates, and who pays it
Inheritance Tax (IHT) is a complicated subject. In fact, IFA Magazine reports that 71% of UK adults don’t fully understand how it works.
This lack of awareness could lead to significant financial burdens for grieving families, who may face an unexpected tax bill at an already difficult time.
When you understand how IHT works, you are empowered to make informed decisions about your estate and plan to help ensure that your financial legacy endures.
I’m here to break down what IHT is, who it affects, and help shed some light on important thresholds and exemptions.
Here’s what you need to know.
Inheritance Tax is a tax on the total estate of someone who has died
An “estate” in this sense encompasses all of your assets, including:
- Property
- Cash
- Investments
- Material possessions
Keep in mind that the above applies after any debts and expenses have been settled.
The people inheriting your estate, or your “beneficiaries”, are not taxed themselves. Rather, your estate is taxed before any assets are distributed.
Typically, the person administering the estate will value it and pay the IHT bill. If you have a will, it is the responsibility of your executor to arrange the IHT payment. If you don’t have a will, someone will be appointed the administrator of your estate, and the same rules will apply.
The standard rate of Inheritance Tax in the UK is 40%. However, this 40% isn’t applied to the entire estate; it’s only charged on the portion of the estate that exceeds certain tax-free thresholds.
Key thresholds and allowances could keep your estate below the taxable amount
Understanding your allowances and thresholds is key to understanding how IHT might affect your estate. That being said, it’s important to note that IHT is only levied on a small number of estates each year, which the BBC states is around 27,800. This amounts to around 4% of estates in total.
Making full use of your allowances and thresholds could help keep you out of that number, or at least lower your liability.
As of the 2025/26 tax year, standard IHT thresholds are:
- The nil-rate band, which is £325,000
- The residence nil-rate band, which is £175,000.
The nil-rate band applies to your estate in general, and the residence nil-rate band provides an additional allowance if you are passing on your main residence to your direct descendants.
This means that if you leave your home to your children or grandchildren, your total tax-free allowance would be £500,000.
Keep in mind that the residence nil-rate band tapers off for high-value estates. If your total estate is worth more than £2 million, the residence nil-rate band is reduced by £1 for every £2 that exceeds the £2 million threshold.
Consider these key exemptions and reliefs when looking at ways to mitigate Inheritance Tax on your estate
Several exemptions and reliefs could reduce or even eliminate an IHT bill, so it’s important to consider these in your financial plan. Each exemption is relevant for the 2025/26 tax year and is subject to change in the future.
Spousal and civil partner exemption
Assets passed to a spouse or civil partner are entirely exempt from IHT, provided they are living in the UK permanently. This means you can leave your entire estate to your husband, wife, or civil partner without any IHT liability.
Moreover, you can combine your allowances with those of your spouse or civil partner. So, if you leave unused nil-rate bands, your spouse may be able to claim them from IHT, essentially doubling what you can pass down tax-free.
Charity exemption
Gifts to qualifying UK-registered charities are exempt from IHT. Furthermore, if you leave at least 10% of the net value of your estate to charity, the IHT rate on the rest of your taxable estate may be reduced.
Lifetime gifts and the 7-year rule
One of the most common ways to reduce IHT is by making gifts during your lifetime. These are also known as potentially exempt transfers (PETs). Generally, no IHT is due on gifts you make if you live for seven years after giving them.
If you die within seven years of making a gift, the gift may be subject to IHT. The amount of tax due depends on when the gift was made, calculated on a sliding scale known as “taper relief”.
The closer to the seven-year mark, the lower your IHT liability will be.
Taper relief rates are as follows:
| Years between gift and death | Rate of tax on the gift |
| 0 – 3 years | 40% |
| 3 – 4 years | 32% |
| 4 – 5 years | 24% |
| 5 – 6 years | 16% |
| 6 – 7 years | 8% |
| 7+ years | 0% |
Remember that taper relief only applies to gifts in excess of the nil-rate band.
Annual exemption
You can give away up to £3,000 each tax year, regardless of how long you live after making the gift. This is known as your annual exemption.
It’s also possible to carry forward any unused annual exemption from the previous tax year, meaning you could potentially give away £6,000 in a single year. You cannot use your annual exemption from more than one previous tax year.
Small gift exemption
You can make unlimited small gifts of up to £250 per person each tax year, provided you haven’t used another exemption on the same person.
Gifts out of surplus income
Regular gifts made from your surplus income are not calculated as part of your estate for IHT purposes. However, these gifts must be consistent and not reduce your standard of living.
To ensure there is no confusion later down the line, be sure to keep careful records when gifting from your surplus income.
Wedding or civil partnership gifts
You can give specific amounts as wedding or civil partnership gifts without them being subject to IHT. These are:
- £5,000 to a child
- £2,500 to a grandchild or great-grandchild
- £1,000 to anyone else
If the wedding or ceremony does not go ahead, the gift will no longer be considered tax-free.
Business and agricultural property relief
Certain business and agricultural assets may qualify for business property relief (BPR) or agricultural property relief (APR). From April 2026, the full 100% relief from IHT will apply to the first £1 million of combined agricultural and business property.
After this, landowners will have access to 50% relief from IHT and pay a reduced rate of up to 20%. This applies in addition to other spousal and nil-rate exemptions.
These reliefs are complicated and require specialist advice.
Pensions
Most pension benefits currently sit outside your estate for IHT purposes, but this is set to change in April 2027. Currently, using your pension to mitigate your IHT liability could be a tax-efficient way to pass on wealth to your beneficiaries, but this will no longer be the case for most estates if the regulations come into play.
This means it’s vital to plan ahead, which is something I can help you with.
Planning for the future by seeking professional advice
Given the various complexities of IHT, proactive planning is key.
Not only is it important to regularly review your estate, so that you have a full understanding of your assets and liabilities, but as rules and regulations change, it may be necessary to adapt your plan.
I can help you navigate the intricacies of IHT to help ensure your loved ones receive as much of your legacy as possible.
Email Marnel.Stafford@fosterdenovo.com or call 07305 970959 or 0207 469 2800 to find out more about how I can help you.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, trust advice, tax planning, or will writing.
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.
