If you’re uncertain about how Inheritance Tax (IHT) works and whether your loved ones will face a bill on your death, then you’re far from alone.

In fact, figures from Canada Life show that one-quarter of UK adults – around 5.2 million people – are unsure whether their estates will be taxed.

IHT is charged at 40% as standard, and you no doubt want to leave as much of your wealth to your loved ones as possible. As a result, while the rules are relatively complicated, it can help to familiarise yourself with some of the key aspects around IHT so you can then make arrangements to mitigate the bill your loved ones may end up with.

Read on to discover how IHT works, how many people it actually affects, and what you may be able to do to mitigate a potential charge.

You may be able to pass on up to £1 million before Inheritance Tax is due

To begin with, it’s crucial to understand when IHT might become payable on your estate.

Your estate is the combined total of all your property and money on your death. Typically, this includes:

 

  • Cash
  • Investments, including those contained in ISAs
  • Property, including your main home
  • Household goods and personal items.

 

Pensions usually fall outside of your estate for IHT purposes.

However, although the standard rate of IHT is 40%, you are able to pass on wealth before your beneficiaries are liable for any tax.

Firstly, everyone has a standard nil-rate band for IHT, standing at £325,000 in 2024/25. If your estate is worth less than this amount, no IHT will typically be due.

Then, if you pass your main residence to direct descendants (that is, children, grandchildren, and so on) then you may be able to benefit from an additional residence nil-rate band. In 2024/25, this is up to £175,000, taking your total tax-free entitlement to up to £500,000.

Furthermore, there is a spousal exemption for IHT, allowing you to pass your wealth on your death to your spouse or civil partner tax-free. What’s more, they’ll inherit your unused nil-rate bands.

So, combined with your spouse or civil partner’s thresholds, that means you may be able to pass on up to £1 million to your chosen beneficiaries without them facing a tax bill.

Bear in mind that for every £2 that your estate exceeds £2 million in value, you’ll see your residence nil-rate band reduced by £1. So, if your estate is worth £2.35 million or more, you usually won’t benefit from this additional threshold at all.

Fewer than 4% of estates paid Inheritance Tax in 2020/21

As you can see, you can pass on a fairly substantial sum of wealth before IHT becomes chargeable.

Of course, if you have a particularly large estate in excess of the nil-rate bands, then that means your beneficiaries could face a bill when you pass away. Seeing as this is typically a charge of 40%, it’s understandable to be concerned about it.

However, while it’s true that certain estates will be taxed, there is a significant disparity between the number of people who think their estate could face IHT and how many actually see a charge.

Canada Life found that nearly 3 in 10 (28%) UK adults believed their estate could face a tax charge. Yet actually, according to government figures, just 3.73% of deaths in the 2020/21 tax year resulted in an IHT charge.

This goes to show that although IHT is often touted as “Britain’s most hated tax”, it actually came into effect on very few estates when data was last available.

You may be able to reduce the size of your estate with careful planning

Even with all this in mind, it’s still possible that your estate might exceed the value of the nil-rate bands. In this case, it could be worth thinking about some of the methods available that can help you reduce the size of your taxable estate and spare your beneficiaries a tax bill on your death.

Some of the methods you might consider could include:

 

  • Making gifts throughout your lifetime. You can make gifts during your lifetime under certain gifting exemptions that mean this money automatically falls outside of your estate. Furthermore, you can also theoretically gift as much as you like and this money will fall outside your estate after seven years. However, if you die before this seven-year threshold, your loved ones may face IHT on these gifts. The rate of tax faced may depend on how soon you die after having made the gift.
  • Putting assets in trust. Trusts are a legal framework that essentially put wealth in someone else’s name, removing it from your taxable estate. That said, there may still be an IHT charge to pay when using trusts and trust planning can be complex. So, you may want to work with a professional to ensure you’ve done this correctly.
  • Holding onto your pension and spending other assets in retirement. As pensions generally fall outside your estate for IHT purposes, you may be able to pass these funds on without an IHT charge and instead live on potentially taxable assets in retirement, such as cash and other investments. Your beneficiaries may face an Income Tax charge when inheriting your pension if you’re over age 75 on your death.

 

It’s important to bear in mind that attempting to mitigate IHT can be complex, and mistakes could prove costly. As such, it can be sensible to seek professional advice if you’re unsure how to do this yourself.

Get in touch

If you would like help managing a potential IHT liability for your beneficiaries, please do get in touch with us at Cordiner Wealth.

Email hello@cordinerwealth.co.uk or call 0113 262 1242 today to speak to an experienced individual.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate estate planning or tax planning.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.