A Guide to Inheritance Tax for Individuals

Inheritance Tax (IHT) is a tax levied on the estate of a person who has died. While it’s a topic many of us would rather avoid, understanding how it works is the first step towards effective estate planning and minimising the tax burden on your loved ones. This guide provides a clear overview of the key components of IHT for individuals.

Estimate Your IHT

Your Tax-Free Allowances

Every individual has tax-free allowances that can be used to reduce their IHT liability.

The Nil-Rate Band (NRB)

The primary allowance is the Nil-Rate Band (NRB). Think of this as your personal IHT-free amount.

Current Threshold: The NRB is £325,000. This figure is frozen until at least April 2028.
How it Works: If the total value of your estate is below this threshold, no IHT is normally due. Any portion of the estate above this amount is typically taxed at 40%.
Transferable Allowance: The NRB is transferable between spouses and civil partners. If one partner dies and leaves their entire estate to the survivor, their £325,000 allowance is unused. It can be passed to the surviving partner, giving them a potential combined NRB of £650,000. Claiming the transferred NRB is not automatic and must be done by the executors of the second estate.

The Residence Nil-Rate Band (RNRB)

Introduced in 2017, the Residence Nil-Rate Band (RNRB) is an additional allowance available when a family home is passed to direct descendants.

Current Threshold: The RNRB is £175,000 per person. This is also frozen until April 2028.
Total Potential Allowance: When combined, the NRB and RNRB can allow an individual to pass on up to £500,000 tax-free, or £1 million for a couple.
Key Conditions:
- The property must have been the deceased’s main residence at some point.
- It must be inherited by “direct descendants,” which includes children (including step-children and adopted children) and grandchildren.
High-Value Estates: For estates valued at over £2 million, the RNRB is gradually reduced. It is tapered by £1 for every £2 the estate is valued over this threshold.

Key IHT Reliefs and Exemptions

Beyond your tax-free allowances, a number of important reliefs and exemptions can significantly reduce an estate’s IHT bill.

Spouse or Civil Partner Exemption

Any assets passed between spouses or civil partners are completely exempt from IHT. There is no upper limit to this exemption, provided both partners are UK-domiciled.

Charitable Giving

Exemption: Any gift left to a qualifying charity in your will is exempt from IHT.
Reduced Rate: If you leave at least 10% of your net estate to charity, the IHT rate on the remainder of the estate is reduced from 40% to 36%.

Business and Agricultural Relief

Business Relief: Can provide 100% or 50% relief on the value of qualifying business assets. This is vital for family-run businesses.
Agricultural Relief: Offers similar relief for qualifying agricultural land and property.

Lifetime Gifts

Gifts made during your lifetime can also be exempt from IHT, provided you follow certain rules.

Annual Exemption: You can give away £3,000 worth of gifts each tax year. This is known as your annual exemption. If you don’t use it one year, you can carry it forward to the next, for one year only.
Small Gifts Exemption: You can make as many small gifts of up to £250 per person as you like each year, as long as the recipient hasn’t received another gift from you.
Gifts out of Normal Expenditure: Regular gifts made from your surplus income can be exempt, provided they don’t affect your standard of living.
The Seven-Year Rule: For larger gifts not covered by an exemption, the “seven-year rule” applies. If you live for seven years after making the gift, it becomes fully exempt from IHT. If you die within seven years, taper relief may apply, reducing the amount of tax payable.

Calculating and Paying IHT

Calculating the final IHT liability involves valuing the entire estate, deducting liabilities, applying all available exemptions and reliefs, and then applying the 40% tax rate to the remaining amount. IHT is generally due within six months of the end of the month in which the person died.

FAQ

What are the main tax-free allowances for Inheritance Tax?

There are two key allowances: the Nil-Rate Band (NRB), which is a £325,000 allowance for everyone, and the Residence Nil-Rate Band (RNRB), an additional £175,000 allowance when a home is passed to direct descendants.

Can my spouse and I combine our allowances?

Yes. The allowances are transferable between spouses and civil partners. A surviving spouse can potentially have a total combined allowance of up to £1 million (£650,000 from the NRB and £350,000 from the RNRB).

What is the current rate of Inheritance Tax?

The standard rate of IHT is 40%. This is charged on the value of an estate that exceeds the available tax-free allowances.

Are all gifts I make during my lifetime exempt from IHT?

Not all. While you have several allowances for lifetime gifts (like the £3,000 annual exemption), larger gifts will only become fully exempt if you live for seven years after making them. This is known as the “seven-year rule.”

Does leaving money to charity affect IHT?

Yes. Gifts to charity are exempt from IHT. Furthermore, if you leave at least 10% of your net estate to charity, the IHT rate on the rest of your estate is reduced from 40% to 36%.

What is the ‘seven-year rule’?

If you make a gift that isn’t covered by an exemption, it’s called a “Potentially Exempt Transfer” (PET). If you live for seven years after making the gift, it becomes fully exempt from IHT. If you die within this period, IHT may be due, though the amount can be reduced by “taper relief.”

Wills & Estate Planning Probate & Estate Administration