What Is Inheritance Tax?
Inheritance tax, usually shortened to IHT, is a tax on the value of everything a person owns when they die. Property, savings, investments, cars, jewellery, business interests and the proceeds of some life policies all go into a single pot called the estate. Debts and funeral costs come off. What is left is measured against a tax free threshold, and anything above that threshold is taxed at 40 percent.
Two things surprise people when they first look at it properly.
The first is how few estates actually pay. Around 4 to 5 percent of deaths result in an inheritance tax bill. The tax raises a lot of money from a small number of estates, which is why it generates far more anxiety than invoices.
The second is that the number of estates paying is rising fast, and not because rates went up. The thresholds have been frozen since 2009 while house prices have roughly doubled. A frozen threshold in a rising market is a tax rise that nobody has to announce. The Office for Budget Responsibility expects inheritance tax receipts to reach around £14.5 billion by 2030/31, up roughly two thirds from where they are now, and almost all of that comes from the freeze rather than from any change in the rate.
Inheritance Tax Rates and Thresholds for 2026/27
| Item | Amount |
|---|---|
| Nil rate band | £325,000 |
| Residence nil rate band | £175,000 |
| Maximum for one person | £500,000 |
| Maximum for a married couple or civil partners | £1,000,000 |
| Standard rate above the threshold | 40% |
| Reduced rate if 10% or more of the net estate goes to charity | 36% |
| Residence band taper threshold | £2,000,000 |
| Business and agricultural property relief allowance (from 6 April 2026) | £2,500,000 |
Both nil rate bands are frozen at these levels until April 2031. The Autumn Budget 2024 extended the freeze to 2030, and the Autumn Budget 2025 added another year on top.
The Nil Rate Band
The nil rate band is the first £325,000 of an estate, and it is taxed at zero. It has been £325,000 since April 2009. Had it simply tracked inflation from that date it would be somewhere near £500,000 now, which gives you a sense of how much of the tax's recent growth is accidental.
The band applies to the whole estate, whatever it is made of. There is no separate allowance for cash or shares or anything else.
The Residence Nil Rate Band
The residence nil rate band adds a further £175,000, but only in specific circumstances. You get it if you leave a home you have lived in to a direct descendant. That means children, grandchildren and their descendants, including step children, adopted children, foster children and children you were appointed guardian of. It also covers the spouse or civil partner of a descendant.
It does not cover nieces, nephews, siblings or friends. If you have no children and you leave your house to your nephew, the residence band is worth nothing to you. Whatever the policy reasoning, the practical effect is that two estates of identical size can face very different bills depending on who inherits.
The band is also capped at the value of the property. Leave a £120,000 flat to your daughter and you get £120,000 of residence band, not £175,000.
The £2 Million Taper, and Why It Is Really a 60 Percent Tax Rate
Here is the part that gets missed. The residence nil rate band is withdrawn on larger estates. For every £2 the estate is worth above £2 million, you lose £1 of residence band. At £2.35 million it has gone completely for a single person.
Nobody frames this as a rate, but it is worth doing so, because the maths is unpleasant. Suppose an estate is at £2.1 million and grows by another £2. That £2 is taxable. It also destroys £1 of residence nil rate band, which makes a further £1 taxable. So £3 becomes taxable on £2 of extra estate, and at 40 percent the tax is £1.20. That is a marginal rate of 60 percent on every pound between £2 million and £2.35 million.
Anyone who has met the income tax trap between £100,000 and £125,140 will recognise the shape of it immediately. It is the same design, applied to estates. For a couple who have both bands available the taper band runs from £2 million all the way to £2.7 million.
Charitable legacies, pension arrangements and lifetime gifting all reduce the estate value that the taper is measured against, so this band is one of the few places in inheritance tax where a relatively modest change produces a disproportionate saving. It is also, in our experience, the single most common thing missed in a will drafted without tax input.
Transferring Allowances Between Spouses
Anything left to a husband, wife or civil partner is exempt from inheritance tax, without limit. That is the spouse exemption, and it is the reason most couples pay nothing on the first death.
Better still, any unused nil rate band and residence nil rate band transfers to the survivor. If the first person to die leaves everything to their spouse, they use none of their own allowances, and the survivor ends up with two of each. That is the origin of the widely quoted £1 million for a couple: £325,000 plus £175,000, doubled.
The transfer is claimed on the second death, not the first, and it is expressed as a percentage of the band rather than a cash figure. If someone died in 2005 having used half their nil rate band, 50 percent transfers, and 50 percent of today's £325,000 is £162,500 rather than half of the 2005 figure. Old estates are worth checking for this. We have seen claims go back several decades.
One thing to note: the exemption applies to spouses and civil partners only. Long term unmarried partners get nothing, however long they have lived together. It is not unusual for a couple in their seventies to discover that marriage is worth several hundred thousand pounds in tax, which is a strange sentence to write but an accurate one.
A Worked Example
Take a widow with an estate of £900,000, made up of a house worth £600,000 and £300,000 of savings and investments. Her husband died some years earlier and left everything to her, so both of his allowances transferred.
| Step | Amount |
|---|---|
| Estate value | £900,000 |
| Her nil rate band | (£325,000) |
| Transferred nil rate band | (£325,000) |
| Her residence nil rate band | (£175,000) |
| Transferred residence nil rate band | (£175,000) |
| Taxable estate | £0 |
Her allowances come to £1 million, so there is no inheritance tax to pay. If the same estate were worth £1.2 million, the taxable amount would be £200,000 and the bill would be £80,000.
Now change one fact. If she leaves the house to her nephew rather than her children, both residence bands disappear. The allowances drop to £650,000, and even the £900,000 estate produces a taxable amount of £250,000 and a bill of £100,000. Same estate, different beneficiary, £100,000 difference.
Our inheritance tax calculator will run these figures for a specific estate, including transferred bands.
What Counts as Part of Your Estate
The estate includes property, land, cash, bank accounts, ISAs, shares, unit trusts, cars, jewellery, business interests, and money owed to you. Life insurance pays into the estate unless the policy is written in trust, which is a simple step that is free to arrange and is very often not arranged.
It also includes your share of jointly owned assets, and certain trusts and gifts made in the last seven years.
Pensions Are Joining the Estate in April 2027
This is the biggest change coming. For deaths on or after 6 April 2027, most unused pension funds and pension death benefits will count as part of the estate for inheritance tax. Death in service benefits from a registered scheme are excluded, and the exemptions for money passing to a spouse, civil partner or charity are kept. Personal representatives, not the pension scheme, will be responsible for reporting and paying the tax.
For twenty years the standard planning line has been to spend other savings first and leave the pension untouched, because the pension sat outside the estate and passed on free of inheritance tax. From April 2027 that logic weakens considerably for anyone whose estate is above the thresholds. There is also a double charge to be aware of: where death occurs at or after 75, the fund can be inside the estate for inheritance tax and then taxed as income in the beneficiary's hands when they draw it.
We would not rush to restructure anything on the strength of a blog post, and pension decisions belong with a regulated financial adviser rather than an accountant. But the direction of travel is clear enough that "leave the pension alone" is no longer a default worth assuming.
The Seven Year Rule and Gifts
You can give away as much as you like, and if you live for seven years after making the gift it falls out of the calculation entirely. Gifts of this kind are called potentially exempt transfers, which is a fair description: exempt if you survive, chargeable if you do not.
Die within seven years and the gift comes back into the calculation. It is set against the nil rate band first, in the order the gifts were made, and only the excess is taxed.
Taper Relief, and the Thing Almost Everyone Gets Wrong
Taper relief reduces the tax on gifts made between three and seven years before death:
| Years between gift and death | Tax rate on the gift |
|---|---|
| Less than 3 | 40% |
| 3 to 4 | 32% |
| 4 to 5 | 24% |
| 5 to 6 | 16% |
| 6 to 7 | 8% |
| 7 or more | 0% |
Now the important bit, and it is the most misunderstood rule in UK personal tax. Taper relief reduces the tax on the gift, not the value of the gift. It only does anything at all once your cumulative gifts in the seven years exceed £325,000, because below that level the gift is covered by the nil rate band and there is no tax to taper in the first place.
So the common belief that a £100,000 gift made four years before death is "only taxed at 24 percent" is wrong twice over. There is no tax on that gift at all, because it sits inside the nil rate band. But the gift has used up £100,000 of the band, which means £100,000 more of the rest of the estate is taxed at 40 percent. The £40,000 cost is real. It just lands somewhere other than where people expect, and taper relief never touches it.
If you take one thing from this article, take that. We have had conversations with people who made large gifts specifically to reach the four year mark, believing they had cut the rate, when what they actually needed was to reach seven years.
Gifts That Are Exempt Immediately
These do not need you to survive seven years:
- Annual exemption: £3,000 per tax year. Unused exemption can be carried forward one year only, so a couple who have used nothing can move £12,000 in one go.
- Small gifts: £250 per person per year, to as many people as you like, as long as you have not used another exemption on that person.
- Wedding gifts: £5,000 to a child, £2,500 to a grandchild or great grandchild, £1,000 to anyone else.
- Gifts to a spouse or civil partner: unlimited.
- Gifts to charities and political parties: unlimited.
- Normal expenditure out of income: unlimited, and covered below.
Contrary to a great deal of speculation beforehand, the Autumn Budget 2025 left the gifting rules alone. The seven year rule, taper relief and the exemption amounts all survived intact.
Business Property Relief and Agricultural Property Relief
If you own a trading business, shares in an unquoted trading company, or farmland you have occupied, those assets can qualify for relief that has historically taken them out of inheritance tax altogether. Business property relief and agricultural property relief are the reason many family firms and farms have passed down intact.
This is the area that has changed most, and where most of what is written online is currently out of date.
The Allowance That Went From £1 Million to £2.5 Million
The Autumn Budget 2024 announced that from 6 April 2026, the 100 percent rate of relief would be capped at £1 million of combined agricultural and business property, with 50 percent relief above that. Fifty percent relief against a 40 percent rate gives an effective rate of 20 percent on the excess.
That £1 million figure ran for over a year. It drove farming protests, a very large volume of press coverage, and an enormous amount of professional commentary.
Then on 23 December 2025 the government announced that the allowance would be £2.5 million, not £1 million, and that it would be transferable between spouses and civil partners. A couple can therefore pass on up to £5 million of business or agricultural assets at 100 percent relief, on top of their nil rate bands. The change was legislated in Finance Bill 2025-26 and takes effect from 6 April 2026 as planned.
We will let readers form their own view about announcing a two and a half fold increase in a tax allowance on 23 December. What we will say is that a considerable amount of the advice sitting on the internet today, including a lot of confidently written AI generated summaries, still quotes £1 million. If your planning was built on the £1 million figure, it is out of date, and it is almost certainly more cautious than it needs to be. That is a better problem than the reverse, but it is still worth revisiting.
The Rest of the Detail
- Above the allowance, relief drops to 50 percent, giving an effective inheritance tax rate of 20 percent on the excess.
- AIM listed shares now attract 50 percent relief rather than 100 percent, and they do not consume the £2.5 million allowance. Portfolios built specifically for the old 100 percent AIM relief now behave quite differently.
- The allowance refreshes every seven years for lifetime gifts, in the same way the nil rate band does.
- Unused allowance transfers to a surviving spouse even if the first death was before 6 April 2026.
- Trusts holding qualifying property before 30 October 2024 get their own allowance. Later trusts from the same settlor share one, allocated in date order.
- Inheritance tax on qualifying business and agricultural assets inherited from 6 April 2026 can be paid over ten interest free annual instalments, which softens the cash flow problem considerably.
If you own a business and have never had it valued for this purpose, that is the starting point. Our guide to how you value a business covers the common methods, and the choice between sole trader and limited company affects what qualifies in the first place.
How and When Inheritance Tax Is Paid
Inheritance tax is due by the end of the sixth month after the month of death. Someone who dies on 12 March has a due date of 30 September. Interest runs from that date whether or not probate has been granted, which produces the well known problem of a bill falling due on an estate whose main asset cannot be sold until probate is issued, and probate is not usually granted until the tax is paid.
The full account, form IHT400, is due within twelve months of the end of the month of death. Many estates fall below the reporting thresholds and need no account at all.
Tax on land, buildings, controlling shareholdings and businesses can be paid in ten annual instalments. Interest applies to most instalment payments, but as noted above, qualifying business and agricultural assets inherited from 6 April 2026 are interest free.
How to Reduce Inheritance Tax
The legitimate options are well established and mostly boring, which is a point in their favour.
Make a will, and check who gets the house. The residence nil rate band depends on a direct descendant inheriting a home. Getting this wrong costs up to £350,000 of allowance for a couple, which is £140,000 of tax.
Marry or enter a civil partnership if it suits you. The spouse exemption and the transferable bands are worth more than any planning technique available to an unmarried couple.
Use the annual exemptions every year. £3,000 each is not dramatic, but it is immediate, requires no survival period and compounds over twenty years.
Give earlier rather than larger. Seven years is the number that matters, and it is the one thing money cannot buy later.
Use the normal expenditure out of income exemption. This is covered below because we think it deserves its own paragraph.
Leave 10 percent or more to charity. This cuts the rate on the rest of the estate from 40 percent to 36 percent. Around the tipping point, giving more to charity can cost the other beneficiaries very little.
Write life policies in trust. Free, quick, and keeps the payout out of the estate.
Check whether business assets qualify for relief, and whether they still will. Relief depends on the business trading rather than holding investments, and businesses drift.
We would add the usual caution. Schemes marketed specifically as inheritance tax avoidance tend to be expensive, fragile and occasionally disclosable to HMRC. The reliefs above are all in the legislation for a reason and none of them require anything clever.
Our View
Three things we would say from doing this work.
The normal expenditure out of income exemption is the most underused relief in the code. If you make regular gifts out of surplus income, establish a pattern, and still maintain your usual standard of living, those gifts are exempt immediately. No seven year wait, no upper limit. A grandparent paying £1,000 a month of school fees from pension income can move £12,000 a year out of the estate with no exposure at all.
The catch is evidence. The exemption is claimed on form IHT403 by the executors, after death, and it requires a schedule of income and expenditure showing the gifts came from surplus income rather than capital. Almost nobody keeps that record while they are alive, and after death the bank statements alone rarely tell the story clearly enough. So a relief that is unlimited and immediate gets lost for want of a spreadsheet. That is a bookkeeping problem wearing a tax costume, and it is precisely the kind of thing worth setting up properly at the start.
Inheritance tax is only a voluntary tax if you start early. The phrase gets quoted a lot, usually cynically. It is half right. Almost every effective tool needs time: seven years for gifts, two years of ownership for business relief, a documented pattern for gifts out of income. The things people reach for in the last eighteen months of life mostly do not work, and some of them make matters worse by triggering capital gains tax or the gift with reservation rules. A conversation at 60 has options that the same conversation at 85 does not.
Watch the interaction with capital gains tax before gifting assets. Assets in an estate get a free uplift to market value on death, so the gain built up in a lifetime disappears. Give the same asset away during your life and you may crystallise capital gains tax immediately, at 18 or 24 percent, in order to save inheritance tax at 40 percent that you may not have paid anyway. For estates comfortably inside the thresholds, gifting an appreciated asset can produce a tax bill where doing nothing would have produced none. This is a genuinely common mistake and it comes from looking at one tax in isolation.
The broader point is that inheritance tax rewards planning far more than it rewards cleverness. The rules are public, the reliefs are generous by international standards, and most of the money lost is lost to inaction rather than to the rate.
How IAK Can Help
We work with business owners and families across North London on the parts of this that sit naturally with an accountant: valuing a business properly, checking whether it qualifies for business property relief and whether it still will in five years, keeping the records that support a normal expenditure out of income claim, and modelling what an estate actually looks like once the allowances are applied.
Our tax planning work takes a view across the taxes rather than one at a time, which matters here because inheritance tax decisions routinely create capital gains tax and income tax consequences. On the personal side, our personal tax service covers the returns and the ongoing position, and our accounting work keeps the business valuation and share structure in a state where relief can actually be claimed.
Estate planning at its fullest also involves a solicitor for the will and trusts, and a regulated financial adviser for pensions and investments. We work alongside both and will say plainly when something sits outside our remit rather than guess at it.
If you want to know where your estate stands, start with our inheritance tax calculator and then contact us for a free consultation. It may also help to read about what an accountant actually does and our guide to capital gains tax, which comes up in almost every estate conversation.
Sources
- How Inheritance Tax works: thresholds, rules and allowances, GOV.UK, on the 40 percent rate, the £325,000 threshold, the 36 percent charity rate and the transferable band.
- Inheritance Tax: gifts and exemptions, GOV.UK, on the seven year rule, taper relief bands and the annual, small gift and wedding exemptions.
- Inheritance Tax: residence nil rate band, GOV.UK, on the £175,000 band, who counts as a direct descendant and the £2 million taper.
- Inheritance tax reliefs threshold to rise to £2.5m for farmers and businesses, GOV.UK, on the 23 December 2025 announcement raising the allowance from £1 million.
- Agricultural property relief and business property relief reforms, GOV.UK, on the £2.5 million allowance, spousal transferability, the 50 percent rate above it and AIM shares.
- Paying Inheritance Tax in yearly instalments, GOV.UK, on the ten year instalment option and the interest free treatment of relievable assets from 6 April 2026.
- Technical note: Inheritance Tax on pensions, GOV.UK, on unused pension funds entering the estate from 6 April 2027 and the death in service exclusion.
- Inheritance tax: current policy and debates, House of Commons Library, on receipts forecasts, the proportion of estates paying and the effect of the threshold freeze.