Inheritance Tax Explained: How It Works in the UK
TL;DR: Inheritance Tax is charged at 40% on estates worth more than £325,000. Most people don't pay it. Married couples can pass up to £1 million tax-free to their children. Everything left to a spouse or charity is exempt.
What Is Inheritance Tax?
Inheritance Tax (IHT) is a tax on the estate of someone who has died. The "estate" includes everything they owned: property, savings, investments, and personal possessions.
The tax applies to the total value of the estate above a tax-free threshold. In the UK, the standard rate is 40% on anything above the threshold.
Despite its reputation, most estates don't pay Inheritance Tax. HMRC data shows only around 4% of deaths result in an IHT charge.
When Is Inheritance Tax Paid?
Inheritance Tax must be paid within 6 months of the end of the month in which the person died. If it's paid late, HMRC charges interest.
The tax is usually paid from the estate itself, before assets are distributed to beneficiaries. This means executors need access to funds before they can fully settle the estate.
For estates where most of the value is tied up in property, HMRC allows payment in instalments over 10 years.
Inheritance Tax Thresholds & Allowances
There are two main tax-free allowances that can shelter your estate from IHT:
Nil-Rate Band: £325,000
Everyone has a basic tax-free allowance of £325,000. The estate pays no tax on this amount. This threshold has been frozen since 2009 and will remain so until at least 2028.
Residence Nil-Rate Band: £175,000
An extra £175,000 allowance applies if you leave your home to direct descendants (children or grandchildren). This brings the total to £500,000 for individuals, or up to £1 million for married couples.
Married couples: If one spouse dies and doesn't use their full allowance, the unused portion transfers to the surviving spouse. This means a couple can potentially leave up to £1 million completely tax-free.
Who Pays Inheritance Tax?
The estate pays the tax, not the beneficiaries directly. The executor or administrator of the estate is responsible for:
- • Valuing the estate
- • Calculating how much IHT is due
- • Paying HMRC from the estate's assets
- • Distributing what's left to beneficiaries
Beneficiaries receive their inheritance after tax has been paid. They don't need to pay income tax on what they inherit.
Exemptions & Reliefs
Several exemptions can significantly reduce or eliminate Inheritance Tax:
Spouse or Civil Partner Exemption
Everything you leave to your spouse or civil partner is completely exempt from IHT. There's no limit. Any unused nil-rate band also transfers to them.
Charity Exemption
Gifts to registered charities are exempt from IHT. If you leave at least 10% of your estate to charity, the IHT rate on the rest drops from 40% to 36%.
Lifetime Gifts
Gifts made more than 7 years before death are exempt. Smaller gifts (up to £3,000 per year) are immediately exempt. Regular gifts from income are also exempt if they don't affect your standard of living.
Worked Example
Let's calculate IHT on an estate worth £600,000 (widower leaving everything to children, including the family home):
If this person's late spouse also left their unused allowances, an additional £500,000 could be claimed, bringing the total tax-free amount to £1 million and leaving nothing to pay.
How to Reduce Inheritance Tax (Overview)
There are legitimate ways to reduce your potential IHT liability:
- Give gifts during your lifetime – gifts become exempt after 7 years
- Leave money to charity – reduces the taxable estate and may lower the rate
- Use your annual exemptions – £3,000 per year plus small gifts
- Consider life insurance in trust – proceeds go directly to beneficiaries
- Business and agricultural relief – can reduce IHT on qualifying assets
IHT planning can be complex. Consider speaking to a qualified financial adviser or solicitor before making significant decisions.
Estimate Your Inheritance Tax
Use our free calculator to get an instant estimate of potential Inheritance Tax on your estate.
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