Often seen as Britain’s ‘most hated tax’ Inheritance tax (IHT) is a tax on your net estate when you die - and by 'estate' we mean your home, savings, investments and any other possessions.
It used to be seen as something only the wealthy paid. However, as house prices have increased, the value of the exemptions we can use to offset against our assets being frozen and due to changes in legislation affecting pensions, agricultural and business assets, this means many more individuals could soon find themselves caught in the IHT net.
What are the IHT changes?
Currently most pensions sit outside your estate for IHT purposes, making them a tax-efficient way to pass on wealth.
However, as announced in the 2024 Autumn Budget, from April 2027, most unused pension funds will no longer be exempt from IHT, and will be included in your estate along with other assets you own.
The rules around passing on a business and agricultural assets are also changing. Certain assets currently qualify for Business Relief and Agricultural Property Relief, with 100% relief from IHT, subject to certain rules being met. However, from April 2026, 100% relief will only apply to the first £2.5 million of those qualifying assets. Anything above that threshold will receive 50% relief, meaning an effective IHT rate of 20%.
The good news is that there are actions you can take to potentially reduce the amount of IHT payable and make sure more of your wealth reaches your loved ones. Here's an overview of the main strategies.
Understanding your tax-free allowances
Everyone has a £325,000 IHT allowance, known as the nil-rate band. If you're leaving your main home to direct descendants such as children or grandchildren, you get an additional £175,000 residence nil-rate band (subject to meeting all the criteria). For married couples and civil partners, these allowances can be combined, potentially allowing you to pass on up to £1 million tax-free.
It's worth noting that in most cases, anything you leave to your spouse or civil partner is exempt from IHT. However, unmarried partners don't receive this exemption.
Making exempt gifts
Gifting during your lifetime is one of the most effective ways to reduce your taxable estate. You have several exemptions available:
- You can give away £3,000 each tax year without it counting towards your estate. If you didn't use last year's allowance, you can carry it forward, allowing a couple to potentially gift £12,000 in one go.
- Small gifts of £250 to as many people as you like apart from those who have benefitted from the annual allowance.
- Wedding gifts have their own rules too - parents can each give £5,000, grandparents £2,500, and anyone else up to £1,000.
- Gifting away your excess income, subject to certain provisions, such as it doesn’t interfere with your standard of living, it comes from real income not capital, and this gifting is normal for you.
- For larger gifts, there's the seven-year rule. If you survive seven years after making a gift, it falls outside your estate entirely. If you pass away within that period, the gift may be subject to IHT, though ‘taper relief’ might be available to reduce the tax payable.
Advice in this area should be sought
It’s important to only make gifts if you're confident you have enough to live on comfortably for the rest of your life. Rising living costs and the potential need for long-term care means your financial security must always come first.
Using trusts and life insurance
Trusts can be powerful tools for IHT planning, allowing you to transfer assets out of your estate while maintaining some control over how they're managed and who can benefit. Different types of trusts suit different situations, so professional advice is essential.
Life insurance policies placed in trust can provide funds to pay any IHT bill without the payout being added to your estate. This ensures your beneficiaries aren't forced to sell assets such as property to meet the tax liability.
IHT planning works best when started early
The rules around IHT are complex and subject to change. What works for one family may not suit another. Professional financial advice can help you navigate the options and create a strategy tailored to your circumstances, ensuring you take advantage of all available reliefs and exemptions.
The resources within these pages can help you find a financial adviser in your local area.
By planning carefully now, you can significantly reduce the IHT burden on your estate and ensure more of your wealth reaches the people and causes you care about most.
The tax treatment of all investments depends on individual circumstances and may be subject to change. You should discuss your own financial arrangements with a specialist tax adviser as the value of any tax reliefs available can vary.
This article reflects our understanding of current legislation, which may change. While we can provide information, we can’t give you advice and therefore we recommend you seek professional advice before making any financial decisions. Investments can go down as well as up, and you may not get back the amount invested. Tax treatment depends on individual circumstances and available reliefs may vary.