How does inheritance tax work?
Inheritance tax can be a complicated business. Here’s our comprehensive guide to how IHT works, including when you need to pay it and how you can reduce your bill.
Inheritance tax can be a complicated business. Here’s our comprehensive guide to how IHT works, including when you need to pay it and how you can reduce your bill.
What is inheritance tax?
When someone dies leaving an estate worth more than £325,000, the government charges inheritance tax (IHT) of 40% on anything over that threshold. An estate consists of money, property and any other assets, minus any debts.
There won’t normally be inheritance tax to pay if:
- The value of your estate is below £325,000 (or £500,000 if you’re leaving your home to your children or grandchildren)
- You leave your estate to your spouse, civil partner, or a charity or amateur sports club.
If you’re concerned about inheritance tax, or don’t know whether you need to pay it, call a tax advisor or solicitor.
The earlier you address the issue, the more chance you’ll have of cutting your loved ones’ bill.
How is inheritance tax calculated?
When someone dies, the government needs to know the value of their assets, minus their liabilities (any outstanding debts). You can calculate this by listing everything they own with a monetary value and reporting this to HMRC. The government’s online inheritance tax checker can help you with this.
- Money in the bank
- Property, including homes abroad
- Possessions such as furniture, jewellery and antiques
- Business interests and investments – depending on the circumstances, these could be eligible for business relief
- Any insurance policies not in trust (includes death in service and some older pension schemes)
Say, for example, the estate is worth £500,000. The tax-free threshold is £325,000, so you won’t need to pay any tax on that. But you’ll be charged 40% on the remaining £175,000.
However, it’s often not as straightforward as that. Other factors will come into play, such as the relationship between you and the beneficiaries, or whether you’re leaving any money to charity.
What’s the inheritance tax allowance?
Inheritance tax is currently charged at 40% on anything above £325,000 (the current IHT threshold). This amount hasn’t changed since 2010-11 and is frozen until 2028. Rising property values mean that many more people are now liable for inheritance tax.
Anything below £325,000 is known as the nil rate band.
If you leave your home to your children or grandchildren, your threshold can increase to £500,000.
If you’re married or in a civil partnership, you can pass any unused inheritance tax thresholds to your other half when you die. This means your combined thresholds can be as much as £1 million before any tax is due.
Any assets left to your spouse or civil partner, or a charity, escape inheritance tax.
How do you avoid inheritance tax?
You can't avoid inheritance tax if your estate is over the threshold. But there are ways you can reduce your inheritance tax liability.
- Charitable donation – you can cut your inheritance tax rate from 40% to 36% by leaving 10% of your ‘net’ estate (the value of your estate above the £325,000 threshold) to charity.
- Residence nil rate band (RNRB) – if you leave your home to a direct descendant, you’re entitled to the RNRB allowance of £175,000 per person. This is in addition to the IHT threshold of £325,000 – making your inheritance tax threshold £500,000.
Direct descendants include children and grandchildren, as well as step, adopted and foster children. Siblings, cousins and nieces and nephews don’t count.
- Passing on your threshold – married couples or civil partners can pass any unused threshold to their partner when they die. So if none of the £325,000 threshold was used when the first partner died, the widow or widower could pass on an estate worth up to £650,000 tax-free, or up to £1 million if leaving their home to children or grandchildren.
- Business relief – if you own a business or held shares in one for two years, this will be considered part of your estate when you die, making it liable for inheritance tax. Depending on the circumstances, it’s possible to get up to 100% business relief. This can be passed on while the owner is alive, or as part of the will.
- Making what are called ‘potentially exempt transfers’, such as gifts.
If in doubt, ask a professional, as inheritance tax is complicated.
How to reduce inheritance tax on property
Under the residence nil rate band (RNRB) allowance, married couples or civil partners can leave a property worth up to £1 million without IHT having to be paid. The allowance only applies to a main property passed on to a direct descendant.
The way the rule works means that, on top of your £325,000 allowance, your direct descendants can get an extra £175,000 tax-free allowance.
Bear in mind that the RNRB is capped at £175,000, or the value of equity in the property if this is lower. So if you only had £50,000 equity in the property, the allowance would be £50,000, not £175,000.
If the estate is worth more than £2 million, the RNRB is reduced, or ‘tapered’, by £1 for every £2 over £2 million. This means that for estates worth more than £2.35 million, the RNRB disappears altogether.
Tenants in common and inheritance tax
When inheriting property that you owned with a person who has died, you don’t have to pay any stamp duty or tax in most cases. What you pay will depend on whether you were ‘joint tenants’ or ‘tenants in common’.
- Joint tenants (or ‘joint owners’ in Scotland) – partners who own the property entirely. The surviving partner will automatically inherit the property you owned together. Any assets that exceed the IHT threshold will still be subject to inheritance tax. This should come out of the deceased’s estate, but if the estate can’t pay it you’ll have to.
- Tenants in common (or ‘common owners’ in Scotland and ‘coparceners’ in Northern Ireland) – partners own a set share of the property. When one dies they can leave their share of the property to another family member, like a child, while the other continues to live in the property.
Why do we have to pay inheritance tax?
Many people question why they’re effectively taxed twice on their assets – once when earning them and again when they die. The idea of inheritance tax is to redistribute wealth for the general good. So instead of the rich getting exponentially richer through large inheritances, a portion of their wealth is redistributed to the public through tax.
When do you pay inheritance tax?
Inheritance tax must be paid within six months of the end of the month the person died. If they died in January, the inheritance tax must be paid by the end of July.
How do you pay inheritance tax?
Inheritance tax can be paid to HMRC via the government’s Direct Payment Scheme. All or part of it can be taken from the deceased person’s bank or building society accounts if the money is available. In some cases, property or other assets may need to be sold to pay the tax. Some people put aside money specifically to pay IHT. This is often done through whole of life insurance.
Can you pay inheritance tax in instalments?
It’s sometimes possible to pay the tax in annual instalments over a 10-year period, but this will incur interest. The first instalment is payable within six months of the death. The remaining instalments become payable each year by that date.
You won’t have to pay interest on the first instalment – unless you pay late. If you do, you’ll pay interest on both:
- The outstanding balance
- The instalment, from the date this is due to the date you pay.
If all the person’s assets have been sold, the tax must be paid in full.
How does inheritance tax work for married couples?
Married couples and civil partners still need to think about inheritance tax.
When you die, inheritance tax won’t apply to assets left to your other half. This means you can leave everything to them, tax free, if you want to. What’s more, married couples, or those in a civil partnership, can pass on any unused IHT threshold, as well as any RNRB, to their partner. So, by the time the second person dies, they can pass on as much as £1 million before being hit by inheritance tax.
|Inheritance tax threshold for partner one
|Residence nil rate band threshold for partner one
|Inheritance tax threshold for partner two
|Residence nil rate band threshold for partner two
With tax thresholds, nil rate bands, multiple people and other potential scenarios, let's look at a real life example that we can all relate to.
An example of how inheritance tax works for married couples
James and Emma are a married couple with two children. If James died first, he could pass all his assets to Emma, along with his £325,000 inheritance tax allowance and £175,000 residence nil rate band allowance for the home they share.
Emma, who has inherited James’ assets, keeps their home and other possessions, but has now effectively doubled her own allowances, taking her combined total, including James’ allowances, to £1 million.
This allows Emma to pass on up to £1 million in assets, including the value of their home, to her two children when she dies.
But if James left assets to anyone besides Emma, his allowance would be impacted. For example, if James decided to leave £50,000 to his sister, the unused inheritance tax threshold passed on to Emma would fall to £275,000. This would leave her with a combined allowance at £950,000.
How does inheritance tax work for unmarried couples?
Unmarried couples don’t have the same IHT benefits as married ones, or those in a civil partnership.
If you don’t name your partner as a beneficiary in your will, they won’t automatically inherit anything you don’t jointly own. That’s why it’s so important to make a will leaving your assets to each other. If you don’t, the surviving partner may have to go to court to make a claim on the estate.
Even if you’re named in each other’s wills, unmarried couples aren’t exempt from inheritance tax. You’ll also lose any unused nil rate band amount when the first partner dies.
How to reduce inheritance tax when you’re not married
There are a few things unmarried couples can do to reduce their inheritance tax liability:
- Transferring assets – if you know which of you is likely to outlive the other, you can transfer joint assets to the other partner. Those assets are then no longer part of your estate and inheritance tax threshold – provided you live for at least seven years afterwards.
- Gifting your assets – giving your assets to your partner (or friends and family) is a good way to avoid inheritance tax, although again you’ll need to live for seven years afterwards for the gift to escape inheritance tax. To avoid unpleasant surprises, it’s worth checking how to gift things properly.
- Put your assets in trust – if your assets are in trust, they no longer make up part of your estate. For example, you could leave assets in a trust to your children, giving them access once they turn 18. Many trusts are still subject to inheritance tax rules and you may be charged various fees, including entry, exit or rolling charges.
- Take out life insurance – this won’t reduce your inheritance tax bill, but it could help cover the cost.
- Leave a portion of your estate to charity – if you leave a minimum of 10% of your ‘net’ estate above the inheritance tax thresholds to a charitable cause, the inheritance tax rate will be reduced from 40% to 36%.
What’s the seven-year rule for inheritance tax?
You don’t have to pay inheritance tax on gifts, including money and valuable assets, if you live for seven years after giving them. But if you die within seven years of making the gift, the recipient may still have to pay inheritance tax.
Gifts above the inheritance tax threshold, made between three and seven years before your death, are taxed on a sliding scale. That’s why it’s important to plan ahead if you’re considering giving your assets away.
- Gifts must be made ‘without reservation’. That means you have no investment in, or right to, the gift once it’s given. For example, you can’t claim you’ve given your home to your children while you’re living there, unless you’re paying the market rent.
- You can give away £3,000 per year (this can be to one person or split between several), without it being added to the value of your estate.
- Birthday and Christmas gifts from your regular income are exempt from IHT, as are regular payments to help with another person’s living costs.
- Gifts to charities and certain other organisations, such as museums or political parties, are inheritance tax-free.
See our full guide to inheritance tax planning and tax-free gifts
What is inheritance tax taper relief?
If you give someone a valuable gift, you could find it’s taxed after your death. Gifts potentially liable for inheritance tax include:
- Household and personal goods, including furniture, jewellery or antiques
- Property, land or buildings
- Stocks and shares listed on the London Stock Exchange
- Unlisted shares held for less than two years before death
Aside from the allowances on gifts discussed above, you may be eligible for ‘taper relief’ on other gifts. This could mean the inheritance tax owed is less than 40%.
The seven-year rule means tax on gifts isn’t due if you live for seven years after giving them. The tax due on gifts given in the seven years before you die will vary, depending on when the gift was received.
Gifts given outside of the nil rate band in the three to seven years before someone dies are taxed on a sliding scale. This is known as taper relief:
Years between gift and death
Rate of tax on gifts
Example gift value
Three to four
Antiques worth £2,000
Four to five
Jewellery worth £5,000
Five to six
Cash gift of £10,000
Six to seven
A car worth £12,000
How to value an estate for inheritance tax
When it comes to valuing a deceased person’s estate, there are three key steps. This process can take several months and includes:
- Reaching out to organisations – the will’s executors will need to contact organisations linked to the deceased. This can include banks, loan providers, mortgage lenders, insurance providers, utility suppliers, and more. The executor may need to provide a death certificate, and deal with requests for information about the deceased’s assets and debts.
- Valuing assets – once the executor has this information, they must value the deceased’s property. This includes everything from their home, vehicles, and jewellery, to furniture and other personal belongings. Values should be based on the item’s price on the open market. Gifts given within seven years of death must be considered, too.
- Reporting to HM Revenue & Customs (HMRC) – once the executor has the total value of the estate, they must inform HMRC, so the inheritance tax can be calculated.
Will my heirs have to pay other taxes on their inheritance?
Before your estate can be distributed to your heirs, inheritance tax and other debts must be paid.
Your heirs may also need to pay:
- Income tax – if they inherit something that produces a regular income, like a business or rental property, your heirs may have to pay income tax.
- Capital gains tax – if your heir sells their inheritance for more than it was worth when you died, they’ll have to pay capital gains tax on any profit above the allowance, which was set at £12,300 a year, but is now £6,000 for 2023-24.
Do you pay inheritance tax on life insurance?
Not necessarily. The pay-out from life insurance policies held in trust is kept separate from your estate so is protected from inheritance tax. To find out more, read our guide to putting life insurance in trust.
A carefully structured life insurance plan, placed in trust, can provide your beneficiaries with money to cover IHT.
Frequently asked questions
Do I still qualify for the residence nil rate band (RNRB) allowance if I downsized my home?
You may still be able to get the RNRB allowance if:
- You downsized to a less valuable home after 8 July 2015
- Your former home would’ve qualified for RNRB if you’d kept it until you died.
- You leave at least some of your estate to your direct descendants.
A claim for the allowance must be made within two years of the death. Keep the details of the move so that the estate’s representative can get the necessary information when they make the claim.
Downsized? Here’s how to work out the RNRB
Can I claim the extra property allowance on a second home?
The RNRB is only available on one home. If the deceased owned and lived in more than one property, the executor can nominate which property benefits from the RNRB. It makes sense to choose the most valuable property, which could be a second home. The RNRB isn’t available for properties the deceased never lived in, such as buy-to-let or investment properties.
If the nominated property doesn’t use all of the RNRB allowance, the remaining allowance can’t be transferred to another property.
How does inheritance tax on overseas property work?
Inheritance tax applies no matter where the assets are located.
But if your permanent home is abroad, inheritance tax will only be owed on your UK assets. Inheritance tax isn’t due on:
- Your permanent overseas residence
- Overseas pensions
- Foreign currency accounts
- Holdings in authorised unit trusts and open-ended investment companies
How does inheritance tax work if I remarry?
If you remarry after your partner has died, you can still use their unused inheritance tax allowance. But you can typically only benefit from two nil-rate bands, including your own, no matter how many times you’ve been married. That’s a total of £650,000, plus any additional property allowance.
If your deceased partner had used part of their allowance, you can use the remainder of their allowance, plus the unused bands of other partners – as long as the total isn’t more than £325,000.
What if my partner dies without a will?
If the deceased had children, then:
- The first £270,000 of the estate goes to the husband, wife or civil partner
- This spouse gets an absolute interest in half of the remainder
- The other half is divided equally between the surviving children
The portion of the estate that passes to the spouse is exempt from inheritance tax. But the part that goes to children uses some of the deceased’s nil-rate band and may be subject to inheritance tax.
These are the intestacy rules in England and Wales. The rules are different in Northern Ireland and Scotland.
How can you claim your partner's unused nil-rate band?
If your spouse or civil partner’s nil-rate threshold wasn’t fully used when they die, you can claim it via HMRC. You may need to get information from the executor to do this.
Sadly, couples who aren’t married or in a civil partnership can’t claim their partner’s unused inheritance tax allowances.
Examples of how unused nil-rate bands work
- A woman who rents, rather than owns, her home dies with an estate worth £750,000. She leaves £260,000 to her children and grandchildren, and the rest to her husband. The inheritance tax threshold was £325,000 at the time.
- The amount left to children and grandchildren uses up 80% (£260,000 ÷ £325,000 x 100) of the threshold. This leaves 20% of the inheritance tax threshold unused.
- When the husband dies, the threshold is still £325,000. His executors can add the unused 20%, worth £65,000 ((20 ÷ 100) × 325,000) to his own threshold, so inheritance tax would only be paid on anything above £390,000.
- The estate’s executor only has to claim any unused nil rate band when the surviving husband, wife or civil partner dies.
Do I have to pay inheritance tax on my parents’ house?
Depending on how much of their RNRB allowances have been used, married couples or civil partners can leave property worth up to £1 million to direct descendants.
If the value of your parents’ estate (including their home) is less than £325,000 you won’t have to pay inheritance tax.