Inheritance tax: how it really works

Inheritance tax has a reputation as Britain's most hated tax, yet it's paid by a minority of estates. Whether your family is in that minority depends mostly on rules that are entirely knowable in advance. Here they are.

The building blocks

The nil rate band (NRB): £325,000. Every individual can pass on this much free of IHT. It has been frozen at this level since 2009 — which, with house price growth, is precisely why more families are being drawn into the net each year.

The residence nil rate band (RNRB): up to £175,000. An extra allowance available when you leave your home (or the proceeds of a former home, thanks to downsizing provisions) to direct descendants — children, grandchildren, stepchildren and their spouses. It's capped at the value of the property interest, and — this is the trap — it tapers away for estates over £2 million, at £1 for every £2 above that line. Large estates can lose it entirely, and the taper creates a nasty effective 60% marginal rate on the slice of estates between £2m and the point the RNRB is exhausted.

The spouse exemption. Anything left to a UK-domiciled spouse or civil partner is completely exempt, regardless of amount. Just as importantly, unused nil rate bands transfer: the survivor's estate can claim up to double both bands.

Put it together: a married couple leaving their home to children can potentially pass on £1 million (2 × £325,000 + 2 × £175,000) before any IHT — provided the estate stays under the £2m taper threshold and the wills are structured to qualify.

What gets counted

Your estate is broadly everything you own at death — property, savings, investments, business interests, personal possessions — minus debts, plus certain gifts made in the previous seven years (see our gifting guide).

Historically, pension funds usually sat outside the estate. That is changing: from April 2027, unused pension funds and death benefits are due to be brought within the scope of IHT — one of the biggest shifts in estate planning in a generation, and covered in its own article on this site.

Life insurance payouts are counted too, unless the policy is written in trust — a simple, free step at the point of setting up cover that many people miss, and which also gets the money to your family faster.

Rate and reliefs

The rate is 40% on the excess above your combined allowances. It drops to 36% if you leave at least 10% of your net estate to charity — which, for estates already giving something to charity, can occasionally mean giving more costs your family almost nothing.

Business Relief and Agricultural Relief can reduce or eliminate IHT on qualifying business and farm assets — powerful but increasingly restricted, and highly fact-specific.

The shape of IHT planning

Most legitimate IHT planning falls into a handful of buckets: spending and enjoying your money; making gifts (outright or via trusts) and surviving seven years; using exemptions that work immediately, like the annual exemption and gifts from surplus income; insuring the liability with a whole-of-life policy in trust; and holding assets that qualify for relief. Each of these has its own article on this site.

The common thread: IHT is largely a voluntary tax for those who plan early, and an unavoidable one for those who don't. Time is the main ingredient.

This article is for general education only and isn't personal advice. Estate planning involves your will, your family circumstances and often trusts — professional advice pays for itself here more reliably than almost anywhere else. Get in touch if you'd like to understand your own position.