Inheritance Tax in the UK: What You Need to Know and Why Planning Matters

Inheritance Tax is one of those figures most people believe they understand, yet few fully appreciate how it operates in practice. In simple terms, it is the government’s share of the estate you leave behind. Without careful planning, that share can be significant.

Understanding the thresholds and the traps within the system is essential if you want to protect your family’s inheritance.

The £325,000 Nil Rate Band

The Nil Rate Band, which is the tax free portion of your estate, currently stands at £325,000. It has remained at that level since 2009 and is frozen until 2028.

Over that same period, property prices have risen substantially and inflation has steadily reduced the real value of money. Despite this, the threshold has not increased. The result is that more estates are being drawn into the scope of Inheritance Tax each year.

This is an example of fiscal drag in action. Families are not necessarily becoming wealthier in real terms, but rising asset values mean they are more likely to exceed a frozen threshold.

Any value above £325,000 is generally taxed at 40 percent. In many parts of the country, a family home alone can push an estate beyond that limit. This is precisely why early planning is so important.

The Additional £175,000 Residence Nil Rate Band

In addition to the standard allowance, there is a further £175,000 available under what is known as the Residence Nil Rate Band.

This applies if you leave your main residence to a direct descendant, such as a child, stepchild, adopted child, foster child or grandchild. If the conditions are met, this allowance is added to the £325,000 Nil Rate Band.

For married couples or civil partners, both allowances can be combined. In effect, this means that up to £1 million can potentially pass to the next generation free of Inheritance Tax.

However, there is an important restriction. If your estate exceeds £2 million, the Residence Nil Rate Band is gradually reduced. For every £2 over the £2 million threshold, £1 of the allowance is withdrawn. If the estate is sufficiently large, the entire £175,000 per person can be lost.

This can result in an unexpected tax bill of up to £70,000 per individual. Importantly, many families reach or exceed £2 million not because they consider themselves exceptionally wealthy, but due to rising property values, pension funds, business interests and accumulated savings.

The 40% Tax Rate

Once all available allowances have been applied, the remaining value of the estate is taxed at 40 percent.

This rate often comes as a surprise when families see the final calculation. However, there is a potential reduction available. If at least 10 percent of the net estate is left to a registered charity, the Inheritance Tax rate on the remaining taxable estate reduces from 40% to 36%.

In certain circumstances, this lower rate can result in a more efficient overall outcome for beneficiaries, even after the charitable gift is taken into account.

It is also important to note that transfers between spouses or civil partners are generally exempt from Inheritance Tax. Assets can pass between them free of tax, with the liability only arising on the second death.

The £2 Million Threshold: A Critical Planning Point

The £2 million threshold represents one of the most significant risks in Inheritance Tax planning.

Once an estate exceeds this level, the Residence Nil Rate Band begins to taper away. Losing this allowance can significantly increase the eventual tax bill.

This issue affects more families than many realise. A valuable home combined with pension benefits, business assets and investments can easily push an estate beyond the £2 million mark. Monitoring this threshold and planning accordingly is therefore essential.

Lifetime Gifting and the Seven Year Rule

One of the most effective strategies for reducing Inheritance Tax is lifetime gifting.

If you make a gift and survive for seven years, the value of that gift generally falls outside your estate for Inheritance Tax purposes. If death occurs within three years, the gift is taxed at the full 40 percent. Between three and seven years, taper relief may reduce the tax payable.

This is why many families adopt a long-term approach, transferring assets gradually over time rather than delaying decisions.

There are also specific exemptions that can be used each year. These include the £3,000 annual exemption, certain wedding gift allowances and small gift exemptions. In addition, gifts made from surplus income can fall outside the estate immediately, provided they do not affect your standard of living and are properly documented.

When used correctly, these allowances can significantly reduce future tax exposure.

Why Planning Makes the Difference

It is often assumed that Inheritance Tax primarily affects the very wealthy. In reality, many ordinary families pay substantial amounts simply because they have not planned in advance.

Wealthier families typically seek professional advice early and use structures such as trusts, holding companies or Family Investment Companies to organise ownership and protect assets. As a result, they often reduce their exposure significantly.

Inheritance Tax is not simply a tax on wealth. It is frequently a tax on a lack of preparation.

An estate valued at £700,000 with no planning in place can pay more tax proportionally than a multi-million-pound estate that has been structured carefully over many years.

Practical Steps to Protect Your Estate

Effective Inheritance Tax planning begins with the fundamentals. A professionally drafted will is essential. It ensures that available allowances are used correctly and that your wishes are clearly recorded.

It is also important to monitor the £2 million threshold, consider lifetime gifting while you are in good health, and explore whether more advanced structures may be appropriate for your circumstances.

Finally, your estate plan should be reviewed regularly. Asset values change, personal circumstances evolve and tax legislation can shift. A plan that was suitable ten years ago may no longer be effective today.

Inheritance Tax is ultimately a set of rules and calculations. With early awareness and informed action, it can be managed. The families who protect their legacy are those who take control rather than leaving matters to chance.

If you have worked hard to build your wealth, it is both reasonable and responsible to ensure that as much of it as possible passes to the people you care about most.

Blog content is for information purposes only and over time may become outdated as the tax landscape is constantly changing, although we do strive to keep it current and up to date. It is written to help you understand your taxes and is not to be relied upon as professional accounting, tax and legal advice. For additional help please contact a professional adviser.