Inheritance Tax is charged at 40% on the part of an estate above £325,000. Most estates pay nothing, because they fall below that threshold or qualify for exemptions. Sensible planning and a proper will can reduce what is owed and make sure the right people benefit.
Of all the questions I am asked, Inheritance Tax is the one that produces the most worry and, I have to say, the most misunderstanding. People arrive at my kitchen table convinced the taxman is going to take nearly half of everything they have worked for. In most cases that is simply not true. A great many estates pay no Inheritance Tax at all.
I have been writing wills and helping Northamptonshire families put their affairs in order for over twenty years. What follows is a plain account of how the tax works, what the thresholds are, and where careful planning genuinely makes a difference. I will be honest with you about the limits of what I can tell you in an article. Tax turns on your own circumstances, and the figures do change, so treat this as a grounding and take proper advice before you act on any of it.
What is Inheritance Tax?
Inheritance Tax is a tax on the estate of someone who has died. Your estate is everything you leave behind, so the house, savings, investments, possessions and any life policies not written in trust, less anything you owe. If the total comes to more than the tax-free threshold, the part above that threshold is taxed at 40%.
The important word there is "above". You do not pay 40% on the whole estate. You pay it only on the slice that sits over the line. And plenty of estates never reach the line in the first place. According to HMRC, only a minority of deaths each year result in an Inheritance Tax bill at all.
The nil-rate band (£325,000, unchanged since 2009)
The tax-free threshold has a rather stiff name. It is called the nil-rate band, and it stands at £325,000. Everything in your estate up to that figure passes free of Inheritance Tax. Only what lies above it is taxed.
That figure has not moved since 2009, and it is currently frozen for some years yet. Worth remembering, because while the band has stayed still, house prices have not. A home that was comfortably under the threshold fifteen years ago may sit well above it today, which is why more ordinary families now find themselves within reach of the tax than once did.
The residence nil-rate band (£175,000 where a home passes to children or grandchildren)
There is a second allowance that helps a good deal of people, and it is worth understanding. It is called the residence nil-rate band, and it is worth up to a further £175,000. It applies where your home, or a share of it, passes to your children or grandchildren.
Put the two bands together and a single person leaving their home to their children can pass on up to £500,000 before any Inheritance Tax is due. For a married couple or civil partners, the allowances can combine, so the survivor's estate may pass on considerably more. The rules here have conditions and tapers attached, and the residence band is reduced for larger estates, so this is one to check against your own numbers rather than assume.
The spouse and civil partner exemption (transfers between them are IHT-free)
This is the exemption that reassures most couples, and rightly so. Anything you leave to your husband, wife or civil partner passes free of Inheritance Tax, whatever the amount. There is no cap on it.
Better still, when the first of a couple dies, any nil-rate band they did not use can transfer to the survivor. So the allowances are not lost. They carry across, which is why the second estate of a married couple often has a much larger tax-free threshold to work with. I should add that this exemption is for spouses and civil partners only. An unmarried partner does not qualify, however long you have been together, which is one of many reasons I encourage couples who are not married to take advice on where they stand.
The most common mistake I see is not a tax mistake at all. It is people assuming the rules will sort themselves out, and never writing anything down.
How gifts work
People often ask whether they can simply give money away to reduce a future tax bill. You can make gifts, and gifting is a real part of planning, but there is a principle you need to understand first, and it catches a lot of people out.
Most gifts you make are treated as what the rules call potentially exempt. The general position is that if you live for seven years after making the gift, it usually falls outside your estate for Inheritance Tax. If you die within those seven years, the gift may be brought back into the reckoning, and tax can be due on it. That is the heart of what people call the seven-year rule.
There are also various allowances that let you give certain amounts each year without them counting against your estate at all. I am deliberately not going to quote those figures here, because they are exactly the sort of number that changes, and I would rather you checked the current position on gov.uk or with an adviser than relied on a figure in an article. Gifting can help, but it needs doing carefully. Give away too much and you may leave yourself short, or fall foul of rules on gifts you continue to benefit from. Sound it out with someone before you start writing cheques.
Trusts and estate planning
Trusts are one of the tools that come up when an estate is larger or the family situation is more involved. In simple terms, a trust lets you set assets aside to be looked after by trustees for the people you choose, under terms you set. Used properly, and in the right circumstances, a trust can help protect certain assets and give you more control over where they end up.
A property trust is one I am asked about often, usually by couples who want to protect a share of their home for their children while making sure the surviving partner is looked after. It is not a device for making tax disappear, and I want to be clear that a trust is not a way of dodging care fees either. Giving your home away to sidestep care costs can be treated as deliberate deprivation of assets, and the local authority can look through it. If you have read about protecting your home from care fees, that piece explains where the sensible line sits.
Trusts are not right for everyone, and a poorly set-up one can cause more trouble than it saves. This is properly individual work, so I always talk it through in person before anyone commits to anything.
Business owners and Business Property Relief
If you own a business or a share in one, there is a relief that may reduce the Inheritance Tax on that part of your estate. It is called Business Property Relief, and for qualifying business assets it has historically taken a large slice, sometimes all, of their value out of the tax calculation.
I will be straight with you here. The rules around Business Property Relief were reformed and the position has been changing, so I am not going to state percentages or thresholds that may be out of date by the time you read this. What I can say is that the relief still exists, that it matters a great deal to business owners, and that this is an area where current professional advice earns its keep many times over. If you run a business, my piece on what Business Property Relief is sets out the principle, and I would treat any planning as a job to do with an up-to-date adviser rather than off the back of an article.
Why a will is the foundation of any plan
Here is the part people skip, and it is the most important. None of the exemptions and allowances I have described work on their own. They need a will behind them to direct where your estate actually goes.
The residence nil-rate band depends on your home passing to your children or grandchildren, which means your will has to leave it to them. The spouse exemption depends on assets passing to your husband, wife or civil partner, which again is something your will sets out. Without a valid will, the intestacy rules take over and decide who inherits, and they take no notice of what would have been sensible for tax. You can read more in my guide on how to make a will in the UK. A will is where any plan starts, and everything else is built on top of it.
Getting the right advice
I have kept this deliberately general, and I have done so on purpose. Inheritance Tax is one of those subjects where the wrong number, applied to the wrong situation, can cost a family dearly. The bands I have quoted are correct as I write, but the reliefs, the tapers and the allowances all turn on detail, and some of them are being reformed.
A gentleman came to see me a couple of years back, quite worried, having read online that his family faced a five-figure tax bill. We sat down and went through what he actually had. Once we accounted for his wife, the transferable band and the fact the house was going to the children, his estate fell comfortably under the threshold. He had spent months fretting over a bill that was never going to arise. The lesson I took from it, and the one I would leave with you, is that general reading only takes you so far. Your own figures are what matter.
At Choice Wills I help people across Northamptonshire, and online throughout England and Wales, put a proper will and a sensible plan in place. The first conversation is free and there is no obligation. If Inheritance Tax is on your mind, I would far rather you asked than worried. Have a look at how I approach estate planning and Inheritance Tax planning, or simply get in touch and we can talk it through.
Common questions
How much is Inheritance Tax?
Inheritance Tax is charged at 40% on the part of an estate that sits above the tax-free threshold. The standard nil-rate band is £325,000. Anything below that threshold is not taxed, and most estates fall below it and pay nothing at all.
What is the nil-rate band?
The nil-rate band is the amount of an estate that can pass free of Inheritance Tax. It is £325,000 and has been unchanged since 2009. There is also a separate residence nil-rate band of £175,000 where a home passes to children or grandchildren.
Do I pay Inheritance Tax on money left to my spouse?
No. Anything you leave to a husband, wife or civil partner passes free of Inheritance Tax, whatever the amount. Any unused nil-rate band can also transfer to them, so it is not wasted when the first of a couple dies.
Can I reduce Inheritance Tax?
Sensible planning can reduce what an estate owes, using the exemptions the law allows, lifetime giving and, where suitable, trusts. Nothing here is a guarantee, and the right approach depends entirely on your own circumstances, so take advice before acting.
Is my home subject to Inheritance Tax?
Your home counts as part of your estate for Inheritance Tax. Where it passes to children or grandchildren, the residence nil-rate band of £175,000 may apply on top of the ordinary nil-rate band, which can lift a good many family homes out of tax altogether.