How it works
How UK inheritance tax works
Inheritance Tax (IHT) is a tax on the estate (property, money and possessions) of a person who has died. It is paid by the estate before beneficiaries receive their inheritance — not by the recipients themselves. The standard rate is 40% on the value of the estate above the applicable threshold.
IHT is only due if the total estate exceeds the available thresholds. For most people this means the nil-rate band (NRB) of £325,000 plus, in many cases, the residence nil-rate band (RNRB) of £175,000, giving a combined threshold of £500,000 per individual.
In practice, only around 4–5% of UK estates pay IHT — but rising property values mean the proportion is increasing. The nil-rate band has been frozen at £325,000 since 2009 and is currently frozen until at least 2028.
IHT is administered by HMRC. The personal representatives (executors) of the estate must submit an IHT return (IHT400 form) and pay any IHT due, typically within 6 months of the date of death. After 6 months, interest accrues on the unpaid amount.
The nil-rate band and residence nil-rate band
The nil-rate band (NRB) is the threshold below which no IHT is charged. For 2026/27 it remains at £325,000 — unchanged since 2009. Any value above this is taxed at 40% (or 36% if at least 10% of the estate is left to charity).
The residence nil-rate band (RNRB) adds up to a further £175,000 to the threshold, but only if: (1) the deceased's main home (or the proceeds from its sale) is included in the estate, and (2) the property passes to direct descendants (children, grandchildren, stepchildren, adopted children). The RNRB tapers at £1 for every £2 of estate over £2 million, phasing out completely at £2.35 million.
Married couples and civil partners can transfer unused thresholds to the surviving spouse. If the first to die leaves everything to the spouse (IHT-free between spouses), their full NRB and RNRB can be transferred, allowing the survivor to use up to £1,000,000 before IHT applies.
| Band | Amount | Conditions |
|---|---|---|
| Nil-rate band (NRB) | £325,000 | Always available; frozen until 2028 |
| Residence nil-rate band (RNRB) | Up to £175,000 | Main home to direct descendants only; tapers above £2m estate |
| Transferred NRB (spouse/CP) | Up to £325,000 | Unused NRB of deceased spouse transferred to survivor |
| Transferred RNRB (spouse/CP) | Up to £175,000 | Unused RNRB of deceased spouse transferred to survivor |
| Maximum combined threshold | Up to £1,000,000 | Married couple, both bands fully available |
Gifts and the 7-year rule
Making gifts during your lifetime can reduce the size of your taxable estate — but the rules are complex. The key concept is the potentially exempt transfer (PET).
A PET is a gift to an individual that will be completely exempt from IHT if the donor survives 7 years after making the gift. If the donor dies within 7 years, the gift may be subject to IHT (or reduce the nil-rate band available for the estate). Taper relief reduces the effective IHT rate on gifts made 3–7 years before death.
Some gifts are exempt immediately (not PETs): the annual exemption (£3,000 per year — unused allowance can carry forward one year), small gift exemption (£250 per person per year), normal expenditure out of income, wedding gifts (up to £5,000 to a child, £2,500 to a grandchild, £1,000 to others), and maintenance payments for family members.
Gifts to charities and political parties are also immediately exempt from IHT, with no limit.
| Years before death | Taper relief | Effective IHT rate on gift |
|---|---|---|
| 0 – 3 years | 0% | 40% |
| 3 – 4 years | 20% | 32% |
| 4 – 5 years | 40% | 24% |
| 5 – 6 years | 60% | 16% |
| 6 – 7 years | 80% | 8% |
| 7+ years | 100% | 0% |
Business and agricultural property relief
Business Property Relief (BPR) is one of the most powerful IHT reliefs available. It can reduce the taxable value of qualifying business assets by 100% or 50%, potentially removing significant value from the estate.
100% BPR applies to: a sole trader business or partnership interest, shares in an unquoted company (including AIM-listed shares — though this is under review), and certain business assets owned by the proprietor and used in the business.
50% BPR applies to: shares in a quoted company where the deceased had control, and land or machinery owned personally but used in a business partnership.
Important 2025/26 change: From April 2026, the government is consulting on limiting 100% BPR on AIM shares — under proposals, only the first £1 million of AIM holdings would attract 100% relief, with 50% on amounts above this. This has not yet been legislated as of June 2026 — check current HMRC guidance.
Agricultural Property Relief (APR) works similarly: 100% relief on the agricultural value of farmland and farm buildings, 50% on farm tenancies. APR does not cover the development value of land — for that, BPR may apply if the conditions are met.
Assets qualifying for 100% Business Property Relief
- A business or interest in a business (sole trader, partnership)
- Unquoted shares in a trading company (including AIM)
- Unquoted shares or securities giving control of a company
- Business assets (land, buildings, machinery) used in the business
Legal ways to reduce IHT
There are several legitimate and HMRC-compliant strategies to reduce an IHT liability. These range from gifting during your lifetime to structuring assets in tax-efficient ways.
Make full use of annual exemptions: The £3,000 annual exemption allows you to give away £3,000 each year (£6,000 if you carry forward last year's unused allowance). Over 10 years, a couple could gift £60,000 completely free of IHT.
Normal expenditure out of income: Gifts that form part of a regular pattern and are made from surplus income (not capital) are immediately exempt from IHT, with no limit. This must be demonstrably from income — keep clear records.
Life insurance in trust: A whole-of-life insurance policy written in trust pays out on death directly to beneficiaries — outside the estate and therefore outside IHT. The premiums themselves may also qualify as normal expenditure out of income.
Charitable giving: Leaving 10% or more of the net estate to charity reduces the IHT rate on the taxable estate from 40% to 36%.
Pension planning: Currently (2026/27), defined contribution pension pots not drawn down at death are outside the estate for IHT. A proposed change from April 2027 would bring unspent pension pots into the estate — review your pension strategy before then.
Key IHT reduction strategies
- Use the £3,000 annual gift exemption (+ £3,000 carry-forward if unused last year)
- Make regular gifts from surplus income (normal expenditure exemption)
- Write life insurance policies in trust
- Leave at least 10% of net estate to charity for the 36% rate
- Transfer unused NRB and RNRB to a surviving spouse
- Consider Business Property Relief-qualifying investments (AIM IHT portfolios)
- Use a whole-of-life policy to cover the projected IHT bill
IHT and pensions: 2026 rules and proposed 2027 changes
One of the most significant IHT planning opportunities in recent years has been unspent pension pots. Under current 2026/27 rules, defined contribution pension funds (including SIPPs) that have not been drawn down at death pass outside the estate and are not subject to IHT. This makes pensions one of the most IHT-efficient assets to hold.
The strategy has been: draw on other assets first in retirement and leave the pension pot intact as long as possible, to pass it to beneficiaries free of IHT. Beneficiaries pay income tax when they draw down an inherited pension, but the fund is outside IHT.
Proposed change from April 2027: The government announced in the October 2024 Autumn Budget that unspent pension pots will be brought into the IHT estate from April 2027. This was a major policy shift. The change would significantly reduce the IHT advantage of holding pension assets.
As of June 2026, the legislation is under consultation and the implementation details are not finalised. Key outstanding questions include treatment of defined benefit pensions and the interaction with existing nomination forms. Financial advice is essential before making any changes to pension drawdown strategy based on the proposed rules.