Inheritance tax planning

Inheritance tax
Five need-to-knows including who pays it and how to legally reduce it

Inheritance tax can be a significant burden on your loved ones, potentially costing them £100,000s upon your passing. In fact, it brought in £7 billion for HM Revenue & Customs in a recent year. However, most people—approximately 96%—won’t pay any inheritance tax at all. For those who do, there are legal ways to reduce or avoid paying a large portion of it. This guide highlights five essential facts about inheritance tax that you should know.

Important: The Government has announced that, from the 2027-28 tax year, pensions will form part of your ‘estate’ – meaning they will be subject inheritance tax (IHT).

Five inheritance tax need-to-knows

Understanding Inheritance Tax: What You Need to Know. Inheritance tax is a highly debated issue. Proponents argue that it prevents the concentration of wealth within families, ensuring that the rich don’t simply pass down their fortunes, allowing for greater redistribution. The tax helps fund public services, benefiting society as a whole.

On the other hand, critics believe that inheritance tax is unfair because individuals already pay taxes on their earnings. Taxing wealth again after it’s passed on feels like double taxation.

With property values soaring in recent years, more people are finding themselves affected by inheritance tax as the threshold remains frozen until April 2030. This has brought the issue to the forefront of political and social discussions. However, it’s important to note that fewer than 5% of estates are actually subject to inheritance tax, meaning the majority of individuals won’t face this charge.

If inheritance tax is a concern for you, whether you’re planning your estate or inheriting, here are five key things to know about inheritance tax, and how you can potentially minimize its impact legally.

1 – Anything left to a spouse or civil partner is EXEMPT from inheritance tax

Inheritance tax is a levy imposed on the estate of a deceased individual. However, it’s important to note that only about 4% of families, or one in 25, are required to pay this tax, as most estates are valued below the inheritance tax threshold.

A key factor in this is that any assets left to a surviving spouse or civil partner are exempt from inheritance tax, regardless of the estate’s overall value. This means that even if the deceased person had a significant fortune, such as a million pounds, leaving it all to their spouse or civil partner would not trigger any inheritance tax. However, any portion of the estate that isn’t directed to the spouse or civil partner could be subject to inheritance tax—details on that are explained below.

It’s important to understand that this exemption does not apply to couples who are merely cohabiting, even if they’ve lived together for many years or have children together. In such cases, any inheritance left to a partner who is not legally married or in a civil partnership will count towards the individual’s tax-free allowance for inheritance tax (more information on this is covered below).

2 – Everyone also has a £325,000 tax-free allowance

You do not pay inheritance tax on the first £325,000 you leave to other people. Even if you decide to leave a portion of your estate to someone other than your spouse or civil partner, inheritance tax is still unlikely to apply.

This is due to the £325,000 inheritance tax-free threshold that everyone is entitled to. Therefore, if the total value of the estate (or any assets not allocated to a spouse or civil partner) is under £325,000, no inheritance tax will be due. The same rule applies if the amount exceeding £325,000 is left to a charity or a community amateur sports club.

To determine the value of an estate, you must calculate the assets owned by the deceased at the time of death. This includes cash, investments, property or business holdings, vehicles, life insurance payouts, and other assets, minus any outstanding debts.

If applicable, the estate may be subject to inheritance tax, which is typically levied at a rate of 40% on any value exceeding the £325,000 threshold. However, if at least 10% of the estate’s value (after deductions) is donated to charity in the will, the tax rate drops to 36%.

The term “theoretically” is used because, depending on specific circumstances, there are strategies to increase the £325,000 tax-free allowance to over £500,000. We will explore these strategies in the following sections.

3 – Passing on a home can boost your allowance to £500,000

Transferring your home could potentially increase your allowance to £500,000 if you pass it down to your children or grandchildren. For the tax year 2024/25, the first £325,000 of an estate is exempt from inheritance tax, with a 40% tax rate applied to any value exceeding that threshold.

The taxable amount will be reduced for individuals who pass their home on to their ‘direct descendants’. This includes children (biological, adopted, foster, or stepchildren) and grandchildren, but excludes nieces, nephews, and other relatives.

This is due to the availability of two separate tax-free allowances:

• £325,000 – this is the basic inheritance tax allowance that everyone gets, which still applies.
• £175,000 – since 2017, individuals have had the opportunity to benefit from the ‘residence nil-rate band,’ often referred to as the ‘main residence’ band. This is an extra allowance that is added to the standard £325,000 inheritance tax threshold, provided you leave your primary home to your children—whether biological, adopted, foster, or stepchildren—or grandchildren.

This means inheritance tax might not be due on the first £500,000 of your estate (£325,000 + £175,000), depending on who you leave your home to. However:

• The £175,000 main residence allowance only applies if your estate is worth less than £2 million. (On estates worth £2 million or more, the main residence allowance will decrease by £1 for every £2 above £2 million that the deceased’s estate is worth.)
• Your home won’t qualify for the £175,000 main residence allowance if it’s in a ‘discretionary will trust’, even if the beneficiaries of the trust are your children or grandchildren.
• If your home’s not worth £175,000 (or £350,000 if two spouses’ allowances are combined – you can’t combine allowances if you’re not married or in a civil partnership), you can’t use the main residence allowance to offset tax against other assets. So, technically it’s an allowance of ‘up to’ £175,000.

An example may help…

If you own an estate valued at £525,000, which includes a property worth £200,000, and choose to leave your home to your children, you won’t be subject to inheritance tax on the first £500,000 of your estate (£325,000 basic allowance + £175,000 main residence allowance). However, a 40% tax will apply to the remaining £25,000 of your home’s value, resulting in a tax bill of £10,000, assuming no charitable donations are made.

On the other hand, if you don’t leave your home to your direct heirs, the first £325,000 of your estate will be exempt from inheritance tax. However, the full £200,000 value of your property will be taxed at 40%, leading to an inheritance tax liability of £80,000.

What happens to the home I share with my partner if we’re not married?

Transfers of property and other assets between married couples or civil partners are typically exempt from inheritance tax. However, this exemption does not apply to unmarried couples.

For unmarried couples who jointly own assets like property, whether inheritance tax will be due upon the death of one partner depends on several factors. These factors include the type of ownership arrangement for the property, whether the deceased had a valid will, and whether their total assets surpassed the inheritance tax threshold.

• If you are joint tenants, meaning you both share full ownership of the property, and your partner has left you everything in their will, the situation becomes straightforward. If your partner’s estate, including the property, exceeds the inheritance tax threshold, tax will apply to the portion of the estate above that limit. Upon your partner’s passing, you would automatically inherit full ownership of the property.

Even if your partner passed away without a will, the property would still be fully transferred to you due to the “right of survivorship.” However, the inheritance tax rules mentioned above would still be relevant. It’s important to note that your partner’s family may still have a claim on other assets, such as life insurance policies and pension investments.

• If you are tenants in common (where each person holds a specific percentage of the property), the situation becomes more complicated. If your partner has written a will that designates their share to you, any inheritance tax will be deducted from the estate before the assets are distributed. Inheritance tax could apply to the property, but this depends on the overall value of their estate.

However, if your partner has not made a will leaving their share to you, and you are tenants in common, their portion will pass on to their relatives. As an unmarried partner, you would only be entitled to the portion of the property that you already own.

It is crucial to create a will specifying who will inherit your property in the event of your death, especially if you co-own it with someone who is not your spouse or child.

4 – Any unused inheritance tax allowance passes to your spouse

As previously mentioned, assets passed on to your spouse or civil partner are exempt from inheritance tax. However, the inheritance tax benefits for married couples extend beyond this…

In addition, your spouse’s inheritance tax threshold increases by the unused portion of your own allowance. This means that together, a married couple can currently leave up to £1 million free of inheritance tax (combining two £325,000 tax-free allowances and two £175,000 main residence allowances).

This can sound complicated, so here’s an example…

Mr. and Mrs. Young’s combined assets total £1 million. When Mr. Y passes away in January 2025, he leaves his entire estate to Mrs. Y. As a result, Mrs. Y inherits his £325,000 tax-free allowance, as well as his £175,000 main residence allowance. This means that Mrs. Y could benefit from a total tax-free allowance of up to £1 million, which includes both her own allowance and the additional allowance she inherited from her late husband.

You don’t need to do anything to activate this – the executors of your will just need to send certain documents to HM Revenue & Customs (HMRC) within two years of your death – see HMRC’s guidelines.

What if my partner died years ago?

These rules are retroactive, meaning they apply even if your partner passed away many years ago. The amount of additional allowance you receive depends on the percentage, rather than the exact amount, of the allowance your spouse had used.

For instance, if your partner passed away in 2012 and had utilized 50% of their nil-rate allowance at that time, you will be entitled to an additional 50% of the current nil-rate allowance (which is 50% of £325,000).

Additionally, you are eligible for the full main residence allowance of £175,000, which your partner didn’t use because it wasn’t available in 2012. The entire main residence allowance is transferable, unless the estate exceeds £2 million, in which case the main residence allowance will be reduced.

This additional allowance, combining your partner’s nil-rate and main residence allowances, is added on top of your own £500,000 total allowance.

An example should help explain…

Imagine Mr. Young passed away several years before Mrs. Young, at a time when the nil-rate band was set at £250,000. He allocated £50,000 to each of his three children, which totaled £150,000, using up 60% of his allowance. The remainder of his estate went to Mrs. Young.

When Mrs. Young passes away, she can currently transfer £500,000 of her estate without incurring tax, due to her own allowance of £325,000 plus the additional £175,000. Moreover, she is entitled to claim the unused portion of Mr. Young’s nil-rate allowance, which was 40% unused. This means she can apply an extra £130,000, which is 40% of the current nil-rate amount, plus the full £175,000 for Mr. Young’s main residence allowance. Therefore, her total tax-free allowance amounts to £500,000 + £305,000, equaling £805,000.

Can I pass on any unused inheritance tax allowance to my partner if we’re not married?

It’s important to note that if you’re not married or in a civil partnership, any unused inheritance tax allowance or residence nil rate band allowance cannot be transferred to your partner. This benefit is only available to married couples or those in civil partnerships.

For those who are cohabiting with a partner and have children together, managing potential inheritance tax liability can become more complex. This is especially true if your estate includes significant assets, such as property. In such cases, it is advisable to consult with a financial expert to help navigate the complexities of inheritance tax planning.

5 – Likely to have to pay? There are ways to legally cut the bill

If you’re concerned about potentially facing inheritance tax, there are legal strategies to reduce the amount owed. Although few people will actually be subject to inheritance tax, understanding how to minimize it is key if you’re one of them.

One major factor in determining inheritance tax is any gifts or money given away during your lifetime. Therefore, it’s important to understand the rules before making gifts.

To put it simply, gifts made more than seven years before your death are generally exempt from inheritance tax, unless they are part of a trust.

However, gifts made within the seven years leading up to your death are included in your £325,000 inheritance tax threshold. Even if the total value of your gifts is less than £325,000, it can still affect how much inheritance tax will be owed on the rest of your estate.

If the total value of gifts made in the seven years before your death exceeds £325,000, the portion above this threshold (along with any inheritance tax on the remainder of your estate) will be subject to tax at a sliding scale, with rates up to 40%.

Before we explore how this sliding scale operates, it’s important to note that everyone is allowed to give away a certain amount in tax-exempt gifts each year…

Tax-free gifts

Each tax year, you have the opportunity to gift a specific amount of money or assets without incurring tax liability, meaning these gifts are not subject to the seven-year inheritance tax rule.

As a result, you can:

• Give away £3,000 (annual exemption). Each tax year, you can give away up to £3,000 without it being included in your estate, meaning it won’t be subject to inheritance tax. If you don’t use the full £3,000 exemption in a given year, the unused portion can be carried over to the following year, though it cannot be carried forward beyond that.
• Give to charities with no limit. Charitable donations are exempt from inheritance tax. Additionally, if a donation to a charity amounts to at least 10% of your estate, the inheritance tax rate on the remaining assets drops from 40% to 36%. For tips on how to include a charity in your will without spending much, check out our guide on affordable and free wills.
• Give £250 to everybody you know. You can give gifts of up to £250 per person annually without incurring inheritance tax. For example, if you have 12 grandchildren, you could give each one £250 as a birthday gift every year. These gifts are separate from the £3,000 annual gift allowance (as mentioned earlier), and you cannot combine multiple gifts to the same person. So, if you’ve already used up your £3,000 annual exemption for someone, you wouldn’t be able to give them the additional £250 gift.
• Give money freely from your income (as long as it doesn’t affect your lifestyle). Inheritance tax is a levy applied to the assets you leave behind. Unlike regular income, such as pensions or wages, which are not considered assets, you can make tax-free gifts from this income as long as it does not negatively impact your quality of life.
• Give wedding gifts (up to a limit). If someone close to you, such as a family member or friend, is tying the knot, you have the opportunity to give them a tax-free monetary gift. This gift can only be made once per year, and there are specific limits on the amount you can offer: £5,000 for a child, £2,500 for a grandchild, and £1,000 for anyone else. These wedding gifts can be combined with your £3,000 annual gift exemption (allowing you to use both for the same individual), but they cannot be combined with the £250 small gift allowance.
• Fund a loved one’s living costs. You can assist with your child’s university tuition and living expenses without any limits on the amount. This contribution can be made tax-free, provided the funds come from your regular income and do not impact your own standard of living. Additionally, this support can be paired with your £3,000 annual exemption for the same individual, although it cannot be combined with the £250 small gift allowance.

See the Gov.uk website for more information about tax-free gifting.

When might inheritance tax be due on a gift?

Inheritance tax will be due on gifts given away less than seven years before you die if the following apply:

• The gifts are not considered tax-free gifts (in other words, they’re not in the list above).
• The gifts amount to more than £325,000 (the tax-free threshold).

(Remember that gifts given away in the seven years before your death which don’t exceed the tax-free threshold will still eat into your estate’s £325,000 tax-free allowance.)

The portion of any gifts above £325,000 will have inheritance tax charged on it on a sliding scale. It works as follows:

Inheritance tax on gifts above £325,000

Here’s an example of how this works in practice:

Kelly Saver has sadly passed away. She was neither married nor in a civil partnership at the time of her death. Over the last nine years of her life, she made several substantial gifts:

• £50,000 to her brother, nine years ago.
• £325,000 to her sister, four years ago.
• £100,000 to a friend, three years ago.

There will be no inheritance tax on the £50,000 she gifted to her brother since it was given more than seven years ago. Similarly, the £325,000 given to her sister is exempt from inheritance tax due to the inheritance tax allowance.

However, her friend is liable for inheritance tax on the £100,000 they received, as this gift occurred after Kelly had exceeded the inheritance tax threshold. The inheritance tax on this amount is 32%, totaling £32,000.

At the time of her passing, Kelly’s remaining estate was valued at £400,000. Since the inheritance tax-free allowance has already been used up by the previous gifts, the full value of the estate will be subject to inheritance tax at a rate of 40%. This results in a tax liability of £160,000.

What constitutes a gift?

A gift should always be a sincere and selfless gesture, given without expecting anything in return. It is something offered to another person freely, without hidden agendas, favors, or expectations of reciprocity. One of the most significant assets people own is their home. However, transferring this asset to your children can be problematic if you continue to live in it, unless you start paying them market rent for the property.

While many gifts can be an effective way to reduce your inheritance tax liability (as previously mentioned), it’s important to be cautious. Any gift given with conditions—other than those made for weddings—especially with the intent of receiving something back, may not achieve the desired tax benefits. Be mindful of these nuances when planning your gifts.

See Gov.uk for more information on what exactly constitutes a gift.

If you’re considering making substantial lifetime gifts, beneficiaries may want to purchase life insurance to cover any potential inheritance tax liabilities. While most gifts placed in trust are now subject to inheritance tax, even when given during your lifetime, seeking expert guidance in this area is crucial.

Are there any exemptions from inheritance tax?

Individuals in specific high-risk professions are eligible for an inheritance tax exemption if they pass away while actively serving. This includes members of the armed forces, police officers, firefighters, paramedics, and humanitarian aid workers.

The exemption also applies if someone is injured during active service and later dies due to that injury, even if they are no longer actively serving at the time of death.

Should I get financial advice?

When considering the potential impact of inheritance tax and the future of your assets, it’s important to take practical steps.

While it’s generally a good idea to handle things on your own to save money, there are situations where seeking professional legal or tax advice is invaluable. Inheritance tax is one of these cases—investing a few hundred pounds in expert advice could help you save hundreds of thousands in taxes.

First, assess whether inheritance tax applies to you. If the combined value of your and your spouse’s estate (including property, savings, inheritance, and remaining pension funds) is under £650,000, you’re likely exempt from this tax. In such cases, seeking professional advice may not be necessary.

For those with larger estates, a qualified independent financial advisor may offer helpful guidance (check our Financial Advice Guide), but for more detailed, specialized advice, a solicitor or tax accountant is recommended. Look for professionals who are members of the Society of Trust and Estate Practitioners (STEP) for expertise, and consider consulting resources like the STEP and Chartered Institute of Taxation websites.

You can also access free inheritance-planning advice for 30 to 60 minutes through VouchedFor, a platform where you can find local independent financial advisers. Simply follow our link, enter your postcode, and get in touch with your selected adviser via phone or online to schedule your complimentary session. This opportunity allows you to ask questions and determine the best steps for your inheritance planning.

To maximize the benefits of your session, it’s helpful to prepare a summary of your financial situation, including savings, debts, income, and expenses, along with any information on existing wills, trusts, and future plans.

Also check our Free Tax Code Calculator guide.