Inheritance Tax Explained for Families

What inheritance tax is

Inheritance tax (IHT) is a tax levied by HMRC on the value of an estate when someone dies. It also applies to certain gifts made during a person's lifetime. The standard rate is 40%, applied to the portion of the estate above the available tax-free allowances.

Despite being described as a tax on the wealthy, inheritance tax increasingly affects ordinary families — particularly those who own property in areas where house prices have risen significantly over the past two decades. A family home bought for £80,000 in the 1980s may now be worth £500,000 or more, pushing the total estate above the threshold even without substantial savings or investments.

HMRC receipts from inheritance tax have risen sharply year on year. In 2023-24, the UK government collected more than £7 billion in IHT — a record figure. With thresholds frozen until at least 2030 and property values continuing to rise, many more families will find themselves facing an IHT bill in the coming years.

The good news is that with careful planning, the IHT position of most estates can be improved significantly. This guide explains the key rules and the most effective strategies for managing the liability.

Current UK tax thresholds

The starting point for inheritance tax is the nil rate band (NRB) — the amount that can pass free of tax. The standard nil rate band is currently £325,000 per person and has been fixed at this level since 2009. It is frozen at this level until at least April 2030.

Inheritance tax is calculated on the net estate — assets minus debts and liabilities, including funeral costs. The tax is normally paid from the estate before assets are distributed to beneficiaries. Executors are responsible for filing the IHT return with HMRC and ensuring the correct amount is paid, usually within six months of the date of death.

The residence nil rate band

The residence nil rate band (RNRB) was introduced in 2017 to help families pass on the family home without IHT. It is currently worth £175,000 per person and is in addition to the standard nil rate band.

To qualify for the RNRB, the home must be left to direct descendants — children, grandchildren, stepchildren, adopted children or foster children. It does not apply if the home is left to a sibling, niece, nephew or other non-lineal descendants.

The RNRB is transferable between spouses and civil partners in the same way as the standard nil rate band. This means a married couple can potentially pass up to £1 million free of IHT: £325,000 + £175,000 each, giving £500,000 per person or £1,000,000 in total.

There is a tapering restriction for larger estates. The RNRB is reduced by £1 for every £2 the estate exceeds £2 million. Estates above £2.35 million receive no RNRB at all. This affects relatively few estates but is an important consideration for high-value estates.

Spouse and civil partner exemptions

One of the most valuable IHT reliefs is the spouse exemption. All assets passing between UK-domiciled spouses or civil partners on death are exempt from inheritance tax, regardless of the amount. A husband can leave his entire estate — however large — to his wife without any IHT liability.

This relief applies to married couples and civil partners. It does not apply to unmarried couples, however long they have been together. This is one of the most significant financial consequences of not being married, particularly for those with substantial assets.

The transferable nil rate band is the mechanism by which unused nil rate bands from the first death pass to the surviving spouse. If the first spouse to die leaves their entire estate to the survivor and uses none of their nil rate band, 100% of the nil rate band transfers to the survivor. This means the survivor's estate can benefit from up to double the standard nil rate band on their death.

Important note: the spouse exemption does not eliminate IHT — it defers it. The tax becomes payable on the second death, when the combined estate passes to the next generation. This is why planning for the second death is crucial, and why trusts, lifetime gifting and other strategies should be considered sooner rather than later.

Gifting rules and exemptions

Making gifts during your lifetime is one of the most effective ways to reduce the value of your estate for IHT purposes. However, the rules are complex and the benefits depend on how long you survive after making the gift.

Annual exemptions

Each person can give away £3,000 per tax year free of IHT. This is the annual exemption. Any unused annual exemption can be carried forward for one year only. A married couple can therefore give away £6,000 per year — or £12,000 in the first year if the previous year's allowance was unused.

There are several additional smaller exemptions: wedding gifts (up to £5,000 to a child, £2,500 to a grandchild, £1,000 to anyone else), small gifts (£250 to any number of individuals per tax year, provided no other exemption has been used for that person), and gifts out of surplus income (which can be larger, provided they are regular, habitual and do not affect the donor's standard of living).

The seven-year rule

Larger gifts — those exceeding the exemptions above — are known as potentially exempt transfers (PETs). A PET becomes fully exempt from IHT if you survive for seven years after making the gift. If you die within seven years, the gift is brought back into your estate for IHT purposes, though taper relief reduces the tax on a sliding scale:

Note: taper relief only reduces the tax on the gift itself — it does not reduce the tax on the rest of the estate. The nil rate band is used first against the gift before any tax is applied.

Trust planning and IHT

Trusts are a powerful tool in inheritance tax planning. They allow assets to be removed from an estate while still providing benefit to family members. The rules around trusts and IHT are complex, but the key principles are as follows.

Discretionary trusts: Assets placed into a discretionary trust are typically outside the estate for IHT purposes provided the settlor survives seven years. The trust itself is subject to periodic IHT charges (every ten years, at up to 6% of the trust value above the nil rate band) and exit charges when assets leave the trust. However, for larger estates, the long-term saving can significantly outweigh these periodic charges.

Will trusts: Trusts created within a will take effect on death and are particularly useful for managing how assets pass to the next generation. A flexible life interest trust allows a surviving spouse to benefit from the estate while ultimately ensuring assets pass to children. A protective property trust preserves a share of the family home, which can be relevant both for IHT and care fee planning.

Business property relief: Business assets, including shares in qualifying companies and interests in trading partnerships, can attract up to 100% relief from IHT. This can be a powerful planning tool for business owners. Agricultural property can also attract similar relief. See our article on business property relief and trusts for more information.

Trust planning needs to be carefully structured to ensure it works as intended and does not fall foul of anti-avoidance rules. Professional advice is essential.

Strategies to reduce inheritance tax

There is no single solution to inheritance tax — the right approach depends on the size of the estate, family circumstances, age and health of the individuals involved, and their objectives. However, the following strategies are commonly used:

• Use all available allowances: Ensure both nil rate bands and residence nil rate bands are used — including transferred allowances from a deceased spouse.
• Make regular lifetime gifts: Use annual exemptions, small gifts exemptions and gifts out of income to reduce the estate over time without triggering the seven-year clock.
• Give larger gifts early: Substantial gifts start the seven-year clock running. Making gifts earlier gives more time to fully exempt them.
• Leave money to charity: Charitable bequests reduce the taxable estate and, if 10% or more of the net estate is left to charity, the IHT rate falls from 40% to 36%.
• Consider life insurance written in trust: A whole-of-life policy written in trust can provide funds to pay the IHT bill without increasing the estate. The payout goes directly to the trust and is available immediately.
• Review pension nominations: Pensions currently sit outside the estate, making them an efficient way to pass wealth. Review nomination forms to ensure they reflect current wishes — especially given upcoming rule changes.
• Use trusts strategically: Trusts can remove assets from the estate, protect specific beneficiaries and give trustees flexibility to manage distributions tax-efficiently.
• Restructure property ownership: Severing a joint tenancy to create a tenancy in common allows each partner's share to be dealt with separately in their will, enabling trust structures to be used on the first death.

At Legacy Lines we provide comprehensive estate planning advice across Kent, helping families understand their IHT position and take practical steps to reduce it. Contact us to discuss your circumstances, or view our pricing.

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