Understanding Inheritance Tax in the UK: Thresholds and Planning

Inheritance Tax (IHT) is charged on the estate of a person who has died, and on certain lifetime gifts. At 40%, it is one of the UK's highest tax rates and can significantly erode the wealth you leave to your family. However, there are substantial exemptions and reliefs available, and proactive planning can dramatically reduce the exposure.

The Nil-Rate Band

The first £325,000 of a deceased person's estate is exempt from IHT — this is the nil-rate band (NRB). This threshold has been frozen since 2009 and remains at £325,000 until at least 2030. On estates above this threshold, IHT is charged at 40% on the excess.

The Residence Nil-Rate Band

An additional Residence Nil-Rate Band (RNRB) of £175,000 applies where a main residence is passed on death to direct descendants (children, grandchildren). This gives a potential total threshold of £500,000 per individual (£325,000 NRB plus £175,000 RNRB). For married couples and civil partners, unused allowances pass to the surviving spouse, giving a potential combined threshold of £1 million. The RNRB is tapered away for estates over £2 million, reducing by £1 for every £2 above that threshold.

Spouse and Civil Partner Exemption

Gifts and legacies to a UK-domiciled spouse or civil partner are completely exempt from IHT, regardless of amount. This is one of the most powerful IHT planning tools — assets can be passed to a surviving spouse free of IHT, with IHT only falling due on the second death (when both nil-rate bands and the RNRB are available).

Gifts During Lifetime

You can reduce your estate by making lifetime gifts. Key exemptions: the Annual Exemption of £3,000 per year (unused allowance can be carried forward one year); Small Gifts Exemption of £250 to any number of people; wedding gifts (up to £5,000 to a child, £2,500 to a grandchild, £1,000 to anyone else); regular gifts out of surplus income (potentially exempt if part of normal expenditure and do not reduce your living standard).

Potentially Exempt Transfers (PETs)

Larger lifetime gifts are Potentially Exempt Transfers. If you survive 7 years from the date of the gift, the PET becomes fully exempt from IHT. If you die within 7 years, IHT is charged on a sliding scale (taper relief) — 40% in years 0–3, reducing to 8% in years 6–7. The 7-year clock starts from the date of the gift.

Business Property Relief

Business Property Relief (BPR) provides 100% IHT exemption on qualifying business assets: shares in an unquoted trading company, a sole trader business, or a partnership interest. It also applies to 50% of shares in a quoted trading company where you have voting control. BPR requires 2 years of ownership. From April 2026, BPR will be restricted to the first £1 million of qualifying assets, with 50% relief (rather than 100%) on the excess — a significant change announced in the October 2024 Budget.

Agricultural Property Relief

Agricultural land and buildings used for farming can qualify for 100% Agricultural Property Relief (APR). Like BPR, APR is being restricted from April 2026 under the same Budget changes — 100% on the first £1 million of qualifying agricultural property, 50% on the excess.

IHT Planning Strategies

Make use of annual gift exemptions every year. Write life insurance policies into trust so the proceeds fall outside your estate. Maximise pension funding — uncrystallised pension pots pass outside your estate (though pension reform from April 2027 will bring undrawn pensions into the IHT estate). Consider making PETs and starting the 7-year clock. Use trusts for assets you wish to give away but need to manage for beneficiaries' benefit.