Inheritance Tax Guide: Thresholds, Rates & Planning

The Complete UK Inheritance Tax Guide for 2025/26

Inheritance Tax (IHT) is charged at 40% on estates above the nil-rate band. Despite affecting a relatively small proportion of estates, it is a significant concern for homeowners across the UK, particularly in London and the South East. With proper planning, the liability can often be reduced or eliminated entirely.

The Nil-Rate Band (NRB)

Every individual has a nil-rate band of £325,000. The portion of your estate up to this threshold is tax-free. Anything above is taxed at 40%.

The NRB has been frozen at £325,000 since 2009 and will remain frozen until at least 2030. As property prices have risen, far more estates now exceed this threshold.

Reduced rate for charitable legacies: If you leave at least 10% of your net estate to charity, the IHT rate drops from 40% to 36%.

Residence Nil-Rate Band (RNRB)

An additional £175,000 allowance is available if you leave your main residence to direct descendants (children, grandchildren, stepchildren, adopted children, foster children).

Conditions:

• The property must have been your residence at some point (not just an investment property)
• It must pass to direct descendants — not siblings, nieces/nephews, or friends
• Available from the 2017/18 tax year onwards

Combined allowances: A single person can pass on £325,000 + £175,000 = £500,000 tax-free. A married couple can pass on up to £1,000,000 tax-free (using both NRBs and both RNRBs).

Tapering for Estates Over £2 Million

The RNRB is reduced by £1 for every £2 that the estate exceeds £2 million. Since the maximum RNRB is £175,000, it is completely lost when the estate exceeds £2,350,000.

This taper applies to the total estate value before any reliefs or exemptions (except business property relief and agricultural property relief, which reduce the estate value before the taper is calculated).

Transferable Allowances Between Spouses

Transfers between spouses and civil partners are completely exempt from IHT — there is no limit. When the first spouse dies, any unused NRB and RNRB can be transferred to the surviving spouse's estate.

Example: If the first spouse leaves everything to the surviving spouse, none of their NRB is used. The surviving spouse then has a combined NRB of £650,000 and combined RNRB of £350,000 — a total of £1,000,000 tax-free.

This means married couples should not rush to use the first spouse's allowance if the surviving spouse may need the assets. The full allowance transfers regardless of when the first spouse died (though the transferable amount is based on the proportion unused, not the cash value at the time).

The 7-Year Rule

Gifts made during your lifetime become exempt from IHT if you survive for 7 years after making the gift. These are called Potentially Exempt Transfers (PETs).

If you die within 7 years, the gift is added back to your estate, but taper relief reduces the tax:

| Years Before Death | IHT Rate on Gift | |---|---| | 0 – 3 years | 40% | | 3 – 4 years | 32% | | 4 – 5 years | 24% | | 5 – 6 years | 16% | | 6 – 7 years | 8% | | 7+ years | 0% (fully exempt) |

Note: Taper relief reduces the tax rate, not the value of the gift. It only applies if the gift (plus any other chargeable gifts in the preceding 7 years) exceeds the NRB.

Exempt Gifts — Annual and One-Off

Annual exemption: Each person can give away £3,000 per tax year, free of IHT. If unused, it can be carried forward by one year only (maximum £6,000 if you missed the previous year).

Small gifts exemption: Gifts of up to £250 per recipient per tax year. You can give £250 to any number of different people. This is separate from the annual exemption but cannot be combined with it for the same person.

Wedding / civil partnership gifts:

• Parents: up to £5,000
• Grandparents / great-grandparents: up to £2,500
• Anyone else: up to £1,000

Gifts from normal income: Regular gifts from surplus income (not capital) are exempt with no limit, provided they do not reduce your standard of living. This is a powerful but underused exemption. Examples include paying a grandchild's school fees or regular contributions to a family member's ISA. You should keep records of income, expenditure, and gifts to evidence the exemption.

Gifts to charities and political parties: Fully exempt.

Gifts between spouses/civil partners: Fully exempt with no limit.

Trusts and IHT

Placing assets into most trusts is a chargeable lifetime transfer. If the value exceeds the available NRB, IHT is charged at 20% immediately (or 40% if paid from the trust). Trusts are also subject to periodic charges every 10 years (up to 6% of the value above the NRB) and exit charges when assets are distributed.

Trusts can still be useful for:

• Protecting assets for vulnerable beneficiaries
• Controlling when beneficiaries receive assets
• Life insurance policies (see below)
• Discretionary distributions

Bare trusts for minors do not incur the 20% entry charge as they are treated as PETs.

Business Property Relief (BPR)

BPR can reduce the taxable value of business assets by 50% or 100%:

• 100% relief: A business or interest in a business, unquoted shares (including AIM shares)
• 50% relief: Quoted shares giving control (50%+), land or buildings used by a partnership or company you control

The business must have been owned for at least 2 years and must not consist mainly of investment activities (e.g., property rental is generally excluded).

AIM shares qualifying for BPR have become a popular IHT planning tool, though they carry investment risk.

Agricultural Property Relief (APR)

APR provides 100% relief on the agricultural value of farming property — farmland, farm buildings, and farmhouses — provided it has been occupied for agricultural purposes for at least 2 years (if farmed by the owner) or 7 years (if let to a tenant).

APR only covers the agricultural value, not any development value. For diversified farm businesses, BPR may cover the non-agricultural element.

Important change: From April 2026, the government has proposed a £1 million cap on combined BPR and APR relief, with the excess taxed at an effective rate of 20%.

Life Insurance in Trust

A life insurance policy written in trust pays out to nominated beneficiaries outside the estate. This does not reduce the IHT liability but provides cash to pay it.

A whole-of-life policy with premiums calculated to cover the expected IHT bill is the classic approach. Because it is in trust, the proceeds:

• Are paid directly to beneficiaries (no probate delays)
• Do not form part of the estate
• Are not subject to IHT

The premiums themselves are treated as gifts and may qualify under the gifts-from-income exemption.

Estate Planning Strategies

1. Make use of annual exemptions — Give away £3,000 each year (£6,000 per couple). Over 20 years, that removes £120,000 from the estate.

2. Give from surplus income — Regular gifts from income are immediately exempt with no 7-year rule. Document everything meticulously.

3. Consider lifetime gifts — Large gifts become fully exempt after 7 years. Start early.

4. Use your pension — Pensions currently sit outside the estate for IHT (though this may change from April 2027). Drawing down ISAs and savings while preserving pension funds can reduce the estate.

5. Leave 10% to charity — Reduces the IHT rate from 40% to 36%. On a £1 million estate (after allowances), this can actually result in the beneficiaries receiving more.

6. Invest in qualifying BPR assets — AIM shares held for 2+ years can qualify for 100% relief (subject to the proposed £1m cap from 2026).

7. Take out life insurance in trust — Provides liquidity to pay any IHT bill without forcing the sale of the family home.

8. Equalise estates between spouses — Ensure both spouses have sufficient assets to use their own NRB and RNRB.

Probate Process Overview

After death, the executors must:

1. Value the estate (all assets and liabilities)
2. Complete IHT forms (IHT400 if tax is due, IHT205/IHT217 for exempt estates)
3. Pay any IHT due (or at least the first instalment) — IHT on property can be paid in 10 annual instalments
4. Apply for a Grant of Probate
5. Collect assets, pay debts, and distribute the estate

IHT must be paid within 6 months of the end of the month of death. Interest accrues after this date. The executors are personally liable for ensuring the correct amount is paid.

When to Get Professional Advice

Consider consulting a solicitor or IHT specialist if:

• Your estate (including property, pensions, and life insurance) exceeds £325,000 (single) or £650,000 (couple)
• You own a business or agricultural property
• You have complex family circumstances (blended families, overseas assets)
• You want to set up trusts
• You are considering lifetime gifts of significant value
• Your estate is near the £2 million RNRB taper threshold

Use our Inheritance Tax Calculator to estimate your estate's potential IHT liability.