Inheritance Tax: Your Complete Guide to UK IHT Rules and Planning

Inheritance Tax (IHT) is often called the most hated tax in Britain, yet it affects relatively few people. Understanding how it works is crucial for effective estate planning and ensuring your loved ones receive as much of your wealth as possible. This comprehensive guide explains everything you need to know about UK inheritance tax.

What is Inheritance Tax?

Inheritance Tax is a tax on the estate (property, money, and possessions) of someone who has died. It’s also charged on some gifts made during a person’s lifetime. In the UK, IHT is administered by HM Revenue and Customs (HMRC) and is one of the most complex areas of taxation.

The tax is designed to prevent the unlimited accumulation of wealth across generations and to raise revenue for the government. However, it’s also one of the most controversial taxes, with critics arguing it’s unfair to tax money that has already been subject to income tax during someone’s lifetime.

Key Fact: Despite its reputation, inheritance tax only affects about 4-5% of estates in the UK each year. However, for those affected, the impact can be significant with a standard rate of 40%.

Current IHT Rates and Thresholds (2024/25)

Nil Rate Band

The nil rate band is the amount you can leave in your estate without paying inheritance tax. For 2024/25, this is £325,000. This threshold has been frozen since 2009 and is set to remain frozen until at least 2028.

Residence Nil Rate Band

Introduced in 2017, the residence nil rate band (RNRB) provides an additional allowance when you leave your main residence to direct descendants (children or grandchildren). For 2024/25, this is £175,000 per person.

Standard Rate

The standard inheritance tax rate is 40% on the value of an estate above the available nil rate bands.

Reduced Rate

If at least 10% of the net estate is left to charity, the inheritance tax rate reduces to 36% on the non-charitable portion.

Allowance/Rate	2024/25 Amount	Notes
Nil Rate Band	£325,000	Per person, transferable to spouse
Residence Nil Rate Band	£175,000	Per person, for main residence to children
Standard Rate	40%	On amounts above nil rate bands
Reduced Rate	36%	When 10%+ left to charity

How Inheritance Tax is Calculated

Step 1: Value the Estate

The first step is to value everything the deceased owned at the date of death, including:

• Property (house, land, buildings)
• Money (bank accounts, cash, premium bonds)
• Household and personal goods
• Investments (shares, unit trusts, bonds)
• Business assets
• Life insurance policies
• Pension death benefits

Step 2: Deduct Debts and Expenses

From the gross estate value, deduct:

• Outstanding mortgages
• Credit card debts and loans
• Funeral expenses
• Professional fees for estate administration

Step 3: Apply Exemptions

Certain gifts and bequests are exempt from inheritance tax, including gifts to spouses, charities, and political parties.

Step 4: Apply Available Nil Rate Bands

Subtract the available nil rate band and residence nil rate band (if applicable) from the net estate.

Step 5: Calculate Tax

Apply the appropriate tax rate (40% or 36%) to any remaining amount.

Example Calculation:
Gross Estate Value: £800,000
Less: Debts and expenses: £50,000
Less: Exempt gifts to spouse: £100,000
Net Chargeable Estate: £650,000
Less: Nil Rate Band: £325,000
Less: Residence Nil Rate Band: £175,000
Taxable Amount: £150,000
IHT at 40%: £60,000

Key Exemptions and Reliefs

Spousal Exemption

Gifts between spouses and civil partners who are both UK domiciled are completely exempt from inheritance tax. This includes gifts made during lifetime and bequests on death.

Important: If your spouse is not UK domiciled, the spousal exemption is limited to £325,000. Special planning may be required for mixed-domicile couples.

Charitable Exemption

Gifts to UK registered charities and certain overseas charities are exempt from inheritance tax. This exemption can also trigger the reduced 36% rate on the rest of the estate.

Business Property Relief (BPR)

Certain business assets can qualify for relief of up to 100%, including:

• Unquoted company shares
• Business assets used in a partnership
• Sole trader business assets
• Controlling shareholdings in quoted companies

Agricultural Property Relief (APR)

Agricultural land and buildings can qualify for relief of up to 100% if certain conditions are met, including occupation and ownership requirements.

Annual Exemption

You can give away £3,000 per year without it counting towards your estate for inheritance tax purposes. Unused annual exemption can be carried forward for one year.

Small Gifts Exemption

You can give up to £250 per person per year to as many people as you like, provided you haven’t used another exemption for the same person.

Wedding Gifts

Special exemptions apply for wedding gifts:

• £5,000 to a child
• £2,500 to a grandchild or great-grandchild
• £1,000 to anyone else

The Seven-Year Rule and Potentially Exempt Transfers

Potentially Exempt Transfers (PETs)

Gifts made to individuals during your lifetime are called potentially exempt transfers. They become fully exempt if you survive for seven years after making the gift.

Taper Relief

If you die within seven years of making a gift, but survive more than three years, taper relief may reduce the inheritance tax due:

Years Between Gift and Death	Tax Rate
0-3 years	40%
3-4 years	32%
4-5 years	24%
5-6 years	16%
6-7 years	8%
7+ years	0%

Planning Tip: Start gifting early in life to maximise the benefit of the seven-year rule. Consider making regular gifts using your annual exemptions and normal expenditure out of income exemption.

Transferring Nil Rate Bands Between Spouses

When the first spouse dies without using their full nil rate band, the unused portion can be transferred to the surviving spouse. This transfer is available for both the nil rate band and the residence nil rate band.

How Transfer Works

• The unused percentage (not the cash amount) is transferred
• The surviving spouse can have up to 200% of the current nil rate band
• For RNRB, this could mean up to £350,000 additional allowance
• Claims must be made within two years of death or within three months of the estate starting to pay inheritance tax

Practical Example

If the first spouse died in 2010 when the nil rate band was £325,000 and left £200,000 to their children, they used 61.5% of their nil rate band. The surviving spouse can claim 38.5% of the current nil rate band as additional allowance.

Common IHT Planning Strategies

Lifetime Giving

Making gifts during your lifetime is one of the most effective ways to reduce inheritance tax:

• Use annual exemptions consistently
• Make larger gifts and rely on the seven-year rule
• Consider gifts with reservation of benefit rules

Trust Planning

Trusts can be powerful tools for inheritance tax planning:

• Discretionary Trusts: Flexible but subject to periodic charges
• Life Interest Trusts: Provide income to beneficiaries
• Bare Trusts: Simple trusts for children

Warning: Trust taxation is complex and has changed significantly in recent years. Always seek professional advice before establishing trusts for tax planning purposes.

Life Insurance Planning

Life insurance can help with inheritance tax in several ways:

• Provide funds to pay the tax bill
• Replace gifted assets for beneficiaries
• Written in trust to avoid adding to the estate

Pension Planning

Pensions can be inheritance tax efficient:

• Most pension funds don’t form part of your estate
• Death benefits can pass to beneficiaries outside inheritance tax
• Consider drawdown vs annuity decisions

Business and Agricultural Assets

Investing in qualifying business or agricultural assets can provide significant inheritance tax relief, but comes with commercial risks that must be carefully considered.

The Residence Nil Rate Band in Detail

Qualifying Conditions

To claim the RNRB, several conditions must be met:

• The property must be your main residence
• It must be inherited by direct descendants
• The estate must be worth less than £2 million (or relief is tapered)

Direct Descendants

Direct descendants include:

• Children (including adopted and step-children)
• Grandchildren and great-grandchildren
• Spouses of descendants (in certain circumstances)

Taper for Large Estates

The RNRB is reduced by £1 for every £2 that the estate exceeds £2 million. This means estates worth £2.35 million or more get no RNRB at all.

Downsizing Provisions

Special rules protect the RNRB if you downsize or sell your home after 8 July 2015, provided other assets of equivalent value are left to direct descendants.

When is Inheritance Tax Due?

Payment Deadlines

Inheritance tax is normally due six months after the end of the month in which death occurred. Interest is charged on late payments.

Paying by Instalments

For certain assets (mainly property and unquoted shares), tax can be paid in ten annual instalments, though interest is usually charged.

Lifetime Gifts

Tax on lifetime gifts that become chargeable because of death within seven years is due six months after the end of the month of death.

Practical Point: Executors can apply for a probate grant before paying inheritance tax in some cases, but this doesn’t change the payment deadline or interest charges.

Record Keeping and Administration

What Records to Keep

• Details of all lifetime gifts made
• Property valuations and purchase documents
• Bank statements and investment records
• Insurance policies and pension details
• Business and agricultural property documentation

Professional Valuations

HMRC requires professional valuations for:

• Property worth over £1,500
• Shares in unquoted companies
• Valuable chattels like art or antiques

IHT Forms

Different forms are required depending on the estate:

• IHT205: For simple estates under the nil rate band
• IHT400: For more complex estates
• IHT100: For lifetime transfers

Recent Changes and Future Developments

Residence Nil Rate Band

The RNRB was introduced in 2017 and reached its full value of £175,000 in 2020/21. It’s now frozen at this level until 2028.

Nil Rate Band Freeze

The nil rate band has been frozen at £325,000 since 2009 and will remain frozen until at least 2028. This means more estates will be caught by inheritance tax as property values rise.

Trust Taxation Changes

Significant changes to trust taxation in 2006 made many traditional inheritance tax planning strategies less effective. Regular reviews of trust-based planning are essential.

Potential Future Changes

Political discussions continue about inheritance tax reform, including:

• Changing rates or thresholds
• Reforming gift rules
• Introducing capital gains tax on death

Stay Updated: Inheritance tax rules change regularly. Always check current rules and consider taking professional advice for significant planning decisions.

Common Mistakes to Avoid

Gifts with Reservation of Benefit

If you give something away but continue to benefit from it, it may remain in your estate for inheritance tax purposes. This commonly affects parents who give their house to children but continue living there.

Not Claiming Transferable Nil Rate Band

Failing to claim unused nil rate band from a deceased spouse can cost up to £130,000 in unnecessary inheritance tax.

Poor Record Keeping

HMRC may challenge valuations and exemption claims if you can’t provide adequate supporting documentation.

Ignoring Domicile Issues

Non-UK domiciled individuals face different inheritance tax rules. Take specialist advice if domicile is an issue.

Last-Minute Planning

Effective inheritance tax planning takes time. Many strategies require you to survive for several years or meet ongoing conditions.

Getting Professional Help

When to Seek Advice

Consider professional advice if:

• Your estate might exceed the nil rate bands
• You have complex assets like business property
• You’re considering significant lifetime gifts
• You have international assets or domicile issues
• You’re dealing with an inheritance tax liability

Types of Advisers

• Solicitors: For will writing and trust work
• Tax advisers: For inheritance tax planning
• Financial planners: For investment and insurance planning
• Accountants: For business property relief planning

Choosing Advisers: Look for specialists with relevant qualifications and experience in inheritance tax. The Society of Trust and Estate Practitioners (STEP) is the leading professional body in this area.

Conclusion

Inheritance tax planning is a complex but important area of financial planning. While only a small percentage of estates currently pay inheritance tax, frozen thresholds and rising property values mean more families may be affected in the future.

The key to effective inheritance tax planning is to start early and review your plans regularly. Simple strategies like making use of annual exemptions and lifetime gifts can be very effective, while more sophisticated planning involving trusts and business assets requires careful professional advice.

Remember that inheritance tax rules change regularly, and what works today may not work tomorrow. Stay informed about changes and don’t let the tax tail wag the commercial dog – make decisions based on your overall financial and family objectives, with tax efficiency as an important but secondary consideration.

Most importantly, inheritance tax planning shouldn’t be done in isolation. It needs to fit with your overall estate planning, including your will, lasting powers of attorney, and provision for long-term care. Take professional advice to ensure all aspects of your estate planning work together effectively.