Inheritance Tax: How to Pass on Assets Tax-Efficiently
By calculatemysalary.co.uk Editorial Team
How inheritance tax works in the UK, what the thresholds are, and the practical (legal) ways to reduce the bill your family ends up paying.
Nobody enjoys thinking about inheritance tax. But if your estate is worth more than £325,000 when you die, and you haven't planned ahead, HMRC will take 40% of everything above that threshold. Given that the average UK house price is now well over £280,000, plenty of ordinary families are caught by this.
The good news is that IHT is one of the most avoidable taxes going, if you plan early enough. Here's how the system works and what you can actually do about it.
Pension change from April 2027: Unused pension funds will be included in your estate for IHT purposes. If pensions are part of your wealth-transfer strategy, review your plans before this kicks in.
How inheritance tax works
IHT is charged at 40% on the value of your estate (property, savings, investments, possessions) above the nil-rate band. For 2025/26:
| Threshold | Amount |
|---|---|
| Nil-rate band | £325,000 |
| Residence nil-rate band | £175,000 (if you leave your home to children or grandchildren) |
Married couples and civil partners can transfer unused allowances to each other. A couple leaving their home to their children can potentially pass on up to £1 million before IHT applies:
- Two nil-rate bands: £650,000
- Two residence nil-rate bands: £350,000
- Combined: £1,000,000
The residence nil-rate band starts tapering if the estate exceeds £2 million, reducing by £1 for every £2 above that figure.
Who actually pays?
Your beneficiaries don't pay IHT directly. The executor settles it from the estate before distributing anything. But if there isn't enough cash in the estate (say it's mostly tied up in property), beneficiaries may need to sell assets or take out a loan to cover the bill.
HMRC charges 8.25% interest on late IHT payments, so getting this sorted promptly matters.
Ways to reduce the bill
Give money away while you're alive
The simplest approach. HMRC allows several gift exemptions each year:
| Gift type | Annual limit |
|---|---|
| Annual exemption | £3,000 per person |
| Small gifts | £250 per recipient |
| Wedding gift (from parent) | £5,000 |
| Wedding gift (from grandparent) | £2,500 |
| Wedding gift (from anyone else) | £1,000 |
You can also make gifts out of surplus income (regular gifts from income you don't need to maintain your standard of living) without limit, provided you can show a pattern.
The seven-year rule
Larger gifts above your exemptions become "potentially exempt transfers" (PETs). Survive seven years after making the gift, and it drops out of your estate completely.
Die within seven years, and the gift gets taxed on a sliding scale:
| Years survived | IHT rate on the gift |
|---|---|
| 0-3 | 40% |
| 3-4 | 32% |
| 4-5 | 24% |
| 5-6 | 16% |
| 6-7 | 8% |
| 7+ | 0% |
This is called taper relief. It only reduces the tax on the gift itself, not on the rest of your estate.
Use trusts
Trusts let you move assets out of your estate while keeping some control over how they're used. Common types in the UK:
- Discretionary trusts give trustees flexibility over distributions
- Bare trusts transfer assets directly to a beneficiary (often used for children)
- Interest in possession trusts give someone the right to income from the trust
Each type has different tax consequences. This is an area where professional advice pays for itself, literally.
Leave your home to your children
This is how you access the residence nil-rate band (£175,000 per person). The home must pass to direct descendants: children, grandchildren, or stepchildren.
If you've downsized or sold the home, you may still qualify under the "downsizing addition" rules, but the calculation gets complicated.
Give 10% to charity, save 4%
Leave at least 10% of your net estate to charity, and the IHT rate drops from 40% to 36% on the rest.
On a taxable estate of £500,000 (above the nil-rate band):
- At 40%: £200,000 tax
- Give £50,000 to charity, pay 36% on £450,000: £162,000 tax
Your beneficiaries receive £288,000 instead of £300,000, but £50,000 goes to a cause you care about and the taxman gets £38,000 less. Depending on your priorities, that's a trade worth making.
Business and agricultural property relief
If you own a qualifying business or agricultural property, relief of 50% or 100% may apply, reducing or eliminating IHT on those assets. The rules are specific, so check whether your assets qualify with a specialist.
ISAs and inheritance tax
ISAs are tax-free for income and gains while you're alive, but they're included in your estate for IHT. The exception: if your ISA passes to your spouse or civil partner, they can inherit the value through an "additional permitted subscription" without triggering IHT.
Mistakes to avoid
Not recording gifts. HMRC can go back years. Keep a log of every gift: amount, date, recipient. Your executors will need this.
Ignoring joint ownership. Jointly owned assets pass automatically to the surviving owner, outside of your will. This is useful for couples but can cause problems if you've assumed everything will follow your will.
Forgetting to update your will. Life changes: marriages, divorces, grandchildren, property purchases. A will from 2005 might not reflect your current wishes or your current tax position.
Get advice
IHT planning gets complicated quickly, especially with trusts, business relief, and the pension changes coming in 2027. An independent financial adviser or solicitor who specialises in estate planning is worth the fee.
- Find a regulated adviser: FCA register
- IHT rules on GOV.UK: gov.uk/inheritance-tax
The earlier you start planning, the more options you have. The seven-year rule alone means that waiting costs you time you can't get back.