UK Inheritance Tax Explained
Inheritance tax is one of the most misunderstood parts of UK tax. Most people either assume it won’t affect them (it might) or panic about it unnecessarily (it might not). Here’s a clear, honest breakdown of how it actually works in 2026.
What is inheritance tax?
Inheritance tax (IHT) is a tax on your estate — everything you own — when you die. It’s charged at 40% on the value above your tax-free allowance. If you leave at least 10% of your net estate to charity, the rate drops to 36%.
HMRC collected £7.5 billion in IHT in 2024/25. Despite being called a tax on the wealthy, rising property prices mean an increasing number of ordinary families are caught by it.
Your tax-free allowances
Everyone gets a nil-rate band (NRB) of £325,000. This is the amount of your estate that’s completely tax-free. It hasn’t changed since 2009 and is frozen until at least 2030.
The residence nil-rate band (RNRB)
If you leave your home (or a share of it) to a direct descendant — children, grandchildren, stepchildren — you get an additional £175,000 allowance. This brings the total individual allowance to up to £500,000.
There’s a catch: the RNRB starts tapering for estates worth more than £2 million, reducing by £1 for every £2 above that threshold.
Married couples and civil partners
Assets left to a spouse or civil partner are completely exempt from IHT. And any unused allowance transfers to the surviving partner. This means a married couple can potentially pass on up to £1,000,000 tax-free:
| Allowance | Individual | Couple (combined) |
|---|---|---|
| Nil-rate band | £325,000 | £650,000 |
| Residence nil-rate band | £175,000 | £350,000 |
| Total | £500,000 | £1,000,000 |
What counts as your estate?
Your estate includes everything you own at death:
- Property — your home and any other properties
- Savings and investments — bank accounts, ISAs, shares, bonds
- Personal possessions — cars, jewellery, art, furniture
- Pensions (from April 2027) — unused DC pension pots will be included
- Life insurance — unless the policy is written in trust
- Gifts made within the last 7 years
This is a major change. Previously, unused DC pensions were generally outside your estate for IHT purposes. From April 2027, they’ll be included. If you have a large pension pot, this could significantly increase your IHT liability. It makes coordinating pension drawdown with estate planning much more important.
Potentially Exempt Transfers (PETs)
You can give away assets during your lifetime. If you survive 7 years after making the gift, it’s completely exempt from IHT. If you die within 7 years, the gift is taxed on a sliding scale known as taper relief:
| Years before death | Tax rate on gift |
|---|---|
| 0-3 years | 40% |
| 3-4 years | 32% |
| 4-5 years | 24% |
| 5-6 years | 16% |
| 6-7 years | 8% |
| 7+ years | 0% (exempt) |
Important: taper relief only reduces the tax rate on the gift — it doesn’t reduce the value of the gift itself. And it only applies if the total gifts exceed the nil-rate band.
Annual exemptions
Some gifts are always exempt, regardless of the 7-year rule:
- £3,000 per year — your annual exemption (unused portion carries forward one year)
- £250 per person — small gifts to any number of individuals
- Wedding gifts — £5,000 to a child, £2,500 to a grandchild, £1,000 to anyone else
- Gifts from normal income — regular gifts that don’t affect your standard of living
- Gifts to charities — always fully exempt
Want to see how this applies to your situation? Isaac models your pensions, tax, and spending — free to start.
Try Isaac free →Ways to reduce your IHT bill
1. Make gifts early
The earlier you gift, the more time for the 7-year clock to run. But only give away what you can genuinely afford — you still need to fund your own retirement.
2. Use Business Relief
From April 2026, Business Relief (BR) and Agricultural Property Relief (APR) share a combined £2,500,000 cap per person. The first £2.5m of qualifying assets receives 100% relief (fully exempt from IHT). Anything above £2.5m receives 50% relief (effective 20% IHT rate on the excess). The allowance is transferable between spouses and civil partners, giving couples up to £5m of combined BR/APR relief. AIM-listed shares (held 2+ years), unlisted businesses, partnerships, and agricultural property all count towards this combined cap.
3. Write life insurance in trust
A life insurance policy written in trust pays out directly to your beneficiaries, outside your estate. This doesn’t reduce your estate but provides cash to pay the IHT bill without your family having to sell assets.
4. Leave 10% to charity
If at least 10% of your net estate goes to charity, the IHT rate drops from 40% to 36%. On a large estate, this can mean you give more to charity and your family still receives more after tax.
5. Spend it
This might sound flippant, but it’s genuinely the most efficient approach for many people. Money spent on your own retirement is money that doesn’t get taxed at 40%. Enjoy it.
Isaac models your full IHT picture — estate composition, allowances, PETs with taper relief, Business Relief, life insurance, and how your liability changes over time. You can see exactly where you stand and experiment with different planning strategies.
A worked example
Sarah, 62, single, owns a home worth £450,000, has £200,000 in ISAs, £350,000 in her pension, and £50,000 in other assets. Her estate totals £1,050,000.
- Nil-rate band: £325,000
- Residence nil-rate band: £175,000 (leaving home to her daughter)
- Taxable estate: £1,050,000 − £500,000 = £550,000
- IHT at 40%: £220,000
If Sarah gifts £100,000 to her daughter now and survives 7 years, her taxable estate drops to £450,000, and the IHT bill falls to £180,000 — a saving of £40,000.
Key takeaways
- IHT is charged at 40% above £325,000 (or £500,000 with the residence nil-rate band)
- Married couples can combine allowances for up to £1,000,000 tax-free
- From April 2027, DC pensions will be included in your estate
- Gifts become exempt after 7 years, with taper relief in between
- Planning early gives you the most options — but get professional advice