Inheritance tax is charged at 40% on everything you leave above your allowances, and with the allowances frozen until 2031, rising house prices are bringing more ordinary families into it every year. Much of it can be avoided legitimately with a well-drafted will and sensible lifetime gifts. But the rules are full of conditions, and the most common mistakes come from what people think they know: that a gift is safe as soon as it is made, that taper relief cuts the tax on any gift, or that giving away the house while living in it takes it out of the estate.
This article explains the allowances and exemptions in England and Wales, how lifetime gifts are taxed, and the traps to look out for.
What is taxed
Inheritance tax is charged on your estate when you die: your home, savings, investments, possessions and business interests, less your debts and funeral costs. If you are a long-term UK resident (broadly, resident in the UK for at least 10 of the previous 20 tax years), that means your assets worldwide.
Three further things can be added to the estate:
- Gifts you made in the seven years before you died, unless an exemption applies.
- Assets you gave away but kept benefiting from, such as a house you gave to your children but carried on living in.
- Unused pension funds and pension death benefits, for deaths on or after 6 April 2027.
The allowances
The nil-rate band
Everyone has a nil-rate band of £325,000. Nothing up to that amount is taxed. It has been £325,000 since 2009, and the government has frozen it until 5 April 2031. Lifetime gifts made in the seven years before death use up the nil-rate band first, leaving less for the estate.
The residence nil-rate band
The residence nil-rate band is an extra allowance of up to £175,000 when a home you have lived in passes to your direct descendants. These include children, grandchildren, stepchildren, adopted and foster children, and their spouses and civil partners. It does not apply to a home left to a partner, a brother or sister, a niece or nephew or a friend.
Three conditions often catch people out:
- The estate must be under £2 million. Above that, the allowance is reduced by £1 for every £2 over £2 million, and it disappears altogether at £2.35 million. The test uses the value of the estate before reliefs and exemptions, so a large spouse gift or a business does not stop the reduction.
- The way the will leaves the house matters. The allowance applies to a home left outright to children, or on certain trusts for them. It is lost if the home goes into a discretionary trust, unless the trustees pass it to the children within two years of the death.
- Downsizing need not lose it. If you have sold your home or moved somewhere smaller, the allowance can often still be claimed, as long as assets of equal value go to your descendants.
Passing allowances to a surviving spouse
Whatever a spouse or civil partner does not use on their death passes to the survivor. If the first to die leaves everything to the survivor, both nil-rate bands and both residence nil-rate bands are usually available on the second death. The executors must claim the transfer, normally within two years of the second death.
- Margaret's estate: £1,100,000
Her home worth £750,000, and £350,000 of savings and investments.
- Two nil-rate bands: £650,000
Her own £325,000, plus Tom's, which he did not use because everything went to Margaret.
- Two residence nil-rate bands: £350,000
Her own and Tom's, because the home goes to their children.
- Inheritance tax: £40,000
40% on the £100,000 above the £1 million of allowances.
Unmarried couples cannot do this. They have no spouse exemption and cannot inherit each other’s unused allowances. We explain the effect, and what couples can do about it, in Second Families, Unmarried Couples and the Family Home.
Exemptions on death
- Spouses and civil partners. Anything left to a spouse or civil partner is free of inheritance tax, without limit. The exception is where the spouse who inherits is not a long-term UK resident and the one who dies is: then the exemption is capped at £325,000 unless the survivor elects to be treated as UK resident.
- Charities. Gifts to UK charities are exempt. If you leave at least 10% of your net estate to charity, the rate on the rest of the taxable estate falls from 40% to 36%.
- Farms and family businesses. Since 6 April 2026, agricultural and business property relief give 100% relief on the first £2.5 million of qualifying property and 50% relief on the rest, so the effective rate on the excess is 20%. A surviving spouse can use the unused part of the first spouse’s £2.5 million. Shares quoted on AIM get 50% relief only.
Lifetime gifts and the seven-year rule
Most gifts you make to another person are “potentially exempt transfers”. There is no tax when you make them. If you survive for seven years, they fall out of account altogether. If you die within seven years, they are added back into your estate when working out the tax.
Gifts that are exempt straight away
Some gifts are exempt as soon as they are made, however soon afterwards you die.
| How much | Points to watch | |
|---|---|---|
| Annual exemption | £3,000 in total each tax year | Any unused amount can be carried forward one year only, and only once this year's £3,000 has been used |
| Small gifts | Up to £250 per person each tax year | Cannot be combined with the annual exemption for the same person |
| Wedding or civil partnership gifts | £5,000 from a parent, £2,500 from a grandparent, £1,000 from anyone else | Must be given on or shortly before the wedding, and the wedding must go ahead |
| Gifts out of surplus income | No limit | Must be regular, come from income rather than savings, and leave you enough to live on in your usual way |
| Spouse, civil partner or charity | No limit | The same rules as for gifts on death |
The exemption for gifts out of surplus income is the most valuable and the least used. Someone with a good pension who cannot spend all of it can pay school fees, fund grandchildren’s savings or pay into a child’s pension each year, and none of it counts towards inheritance tax, however large. The catch is evidence: executors will have to show HMRC that the gifts came from income and did not reduce the donor’s standard of living, so a record of income, spending and gifts should be kept every year.
Taper relief
If you die between three and seven years after a gift, and tax is payable on the gift itself, taper relief reduces that tax.
| Reduction in the tax | Effective rate | |
|---|---|---|
| Less than 3 years | None | 40% |
| 3 to 4 years | 20% | 32% |
| 4 to 5 years | 40% | 24% |
| 5 to 6 years | 60% | 16% |
| 6 to 7 years | 80% | 8% |
| 7 years or more | The gift falls out of account | Nil |
The traps
Trap 1: taper relief usually does not help
Taper relief only reduces tax on the gift itself, and a gift is only taxed if it, together with earlier gifts, is more than the nil-rate band. For most families it never is. The gift is not taxed, but it uses up the nil-rate band, and the estate pays the extra tax instead.
| Peter lives 7 years | Peter dies after 4½ years | |
|---|---|---|
| Gift counted | Nothing | £194,000, after two years' annual exemptions |
| Tax on the gift | None | None, so taper relief has nothing to reduce |
| Nil-rate band left for his estate | £325,000 | £131,000 |
| Extra tax on his estate | £0 | £77,600 |
The extra tax comes out of the estate, so it falls on whoever inherits it, not on the daughter who received the gift. If those are different people, the will should deal with it. Life insurance written in trust is a common way to cover the tax during the seven years.
Trap 2: giving something away but keeping the benefit
If you give an asset away but continue to benefit from it, the “gift with reservation of benefit” rules treat it as still part of your estate when you die, however long ago the gift was made. The classic example is giving your home to your children and carrying on living there rent-free.
It can be worse than doing nothing. The house is still taxed in your estate, but because your children already own it, they do not get the usual capital gains tax “uplift” on your death, and may pay capital gains tax on the increase in value since the gift when they sell. They also own a house that can be affected by their own divorce, debts or bankruptcy.
The rules do not apply if you pay the children a full market rent, and there are limited arrangements that can work where a child lives in the house with you and you share the costs. Both need advice before anything is signed.
Trap 3: gifts into trust
A gift into most kinds of trust is not a potentially exempt transfer. It is taxed immediately at 20% on anything above your available nil-rate band, with more to pay if you die within seven years, and the trust can face charges of up to 6% every ten years. A gift into trust can also affect the tax on gifts made up to seven years after it, so the look-back can stretch to fourteen years. Trusts made in a will are taxed differently, and are often the better way to protect an inheritance.
Trap 4: the £2 million cliff edge
The residence nil-rate band is reduced for estates over £2 million. For a widow or widower claiming both spouses’ allowances, the £350,000 is lost entirely once the estate reaches £2.7 million. Because the test includes business assets and, from April 2027, pensions, estates that look comfortably below £2 million can be pushed over it. Lifetime gifts, or leaving some assets on the first death to the children rather than to the surviving spouse, can keep the estate under the threshold.
Trap 5: no records
Executors must report gifts made in the seven years before death, and HMRC asks for details. Records made at the time are far easier to rely on than recollections years later. Keep a note of each gift: the date, who received it, how much it was, and which exemption you are relying on.
Trap 6: giving assets away to avoid care fees
Inheritance tax planning and care fees planning are not the same. If a local authority concludes that you gave assets away deliberately to avoid paying for care, it can assess you as though you still own them.
Pensions from April 2027
From 6 April 2027 most unused pension funds and pension death benefits will count as part of the estate. Death-in-service benefits will not. Pension money left to a spouse, civil partner or charity will still be exempt.
For many people this is the biggest change in years. Pensions have been a common way to pass on wealth free of inheritance tax, and many people have spent other savings first and left their pension untouched for that reason. That approach needs to be reviewed:
- More estates will pay tax, and more will go over the £2 million limit and lose the residence nil-rate band.
- The executors are responsible for the tax. They will need information from the pension schemes, and beneficiaries can ask a scheme to pay the tax on their share. In the October 2026 Budget the government proposed letting executors ask schemes to pay the tax directly as well.
- Income tax can apply on top. If the pension holder dies at 75 or over, the beneficiaries also pay income tax on what they draw from the pension.
- Nominations matter more than ever. Check who you have nominated with each pension scheme, and how that fits with your will.
Paying the tax
Inheritance tax is due by the end of the sixth month after the month of death, and interest runs after that. Executors usually have to pay at least some of it before probate is granted, which can be difficult when the deceased’s accounts are frozen until then. Banks and building societies can usually pay the tax directly from the deceased’s accounts. Tax on a house, and on business and farm property, can be paid in ten annual instalments. Interest is charged on the house instalments, but not on the business and farm instalments.
A checklist
- Work out what your estate is worth, including your share of the home, pensions and any life policies not in trust.
- Check your will makes full use of both allowances, especially the residence nil-rate band, and that it does not lose them through the way it leaves the home.
- Use the annual exemptions every year, and consider regular gifts out of surplus income if you can afford them.
- Make larger gifts early, outright and with nothing kept back, and consider life insurance in trust to cover the seven years.
- Keep a record of every gift.
- Review your pensions and nominations before April 2027.
How we can help
Thirsk Winton LLP’s private client team advises on inheritance tax planning, wills, trusts and lifetime gifts. We can review your estate and your existing will, show you how the allowances apply to your family, and set up gifts and trusts that work as intended. When someone has died, we help executors value the estate, work out and pay the tax, and deal with HMRC as part of probate.
For advice, please contact Salma Butt on 020 8505 4777 or at sbutt@thirskwinton.co.uk.
This article is for general information only and reflects the law at the date of publication. It is not legal advice and should not be relied on as such. For advice on your own circumstances please contact us.