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A quick guide to Inheritance Tax

by Oliver Dorrington

Inheritance Tax (IHT) has been in the news a great deal recently, with some arguing for its abolition while others call for reform. This article answers some of the common questions that we are asked.

What is Inheritance Tax?

IHT is a tax on the estate of someone who has died, which includes all property, possessions, and money. In the 2022/23 tax year, IHT generated a record £7.1bn for the UK Government, a £1bn increase from the previous year, but it still represents less than 1% of the Government's overall tax receipts.

How much is Inheritance Tax?

The standard IHT rate is 40% and is only applicable to the portion of your estate that exceeds the tax-free threshold, currently set at £325,000, known as the nil-rate band.

It is possible to transfer any unused portion of the nil-rate band and residence nil-rate band between spouses or civil partners upon the first partner's death.

There is usually no tax to be paid if:

  • the value of your estate is below £325,000
  • you leave everything above the threshold to your spouse or civil partner
  • you leave everything above the threshold to an exempt beneficiary, such as a charity or a community amateur sports club
  • the value of your estate exceeds the £325,000 threshold, the part above the threshold may be subject to tax at a rate of 40%.

For instance, if your estate is worth £625,000 and your IHT threshold is £325,000, the tax charged will be on the £300,000 difference (£625,000 - £325,000). The tax would amount to 40% of £300,000, resulting in a potential payment of £120,000.

Who pays Inheritance Tax?

Executors of an estate are responsible for valuing the assets, calculating the inheritance tax liability, and making the necessary tax payments to HMRC. In the absence of a will, the administrator of the estate handles the payment. Once the tax and debts are settled, the executor or administrator can distribute the remaining estate.

Non-domiciled individuals who are UK residents have different rules for inheritance tax.  Care is needed however, as you can become deemed UK domiciled for inheritance tax purposes after spending 15 years in the UK.

When do you have to pay Inheritance Tax?

Inheritance Tax must be paid by the end of the sixth month after the person's death. Failure to do so will result in HMRC charging interest.

If you have been appointed as the executor or administrator of the estate, you must complete and submit an account of the estate within a year of the death to avoid penalties.

Inheritance Tax gifts, reliefs, and exemptions

Some gifts and properties are exempt from Inheritance Tax, such as certain wedding gifts and charitable donations. Relief may also be available for certain types of property, like farms and business assets.

An individual can make gifts up to a specific limit each tax year without incurring an inheritance tax liability. This is known as the 'annual exemption.' As of 2023, the annual exemption stands at £3,000. If an individual did not utilise their annual exemption during the 2022/23 tax year, they are able to carry this forward to the 2023/24 tax year. However, the annual exemptions are only carried forward for one year and if it is not utilised, it is lost. Additionally, small gifts of up to £250 per person can be made to an unlimited number of people without being subject to inheritance tax.

Gifts made within seven years of death may be subject to inheritance tax. These gifts are known as potentially exempt transfers (PETs). However, there are rules and limits on how much can be gifted tax-free.

Gifts made more than seven years before death are generally exempt from inheritance tax.

The amount of tax due depends on the value of the gift, when it was given, and to whom.

Gifts out of regular income

It is possible for an individual to make payments in excess of the £3,000 annual exemption without giving rise to an Inheritance Tax liability. This is known as making gifts out of regular income. For a gift to qualify for this exemption, an individual must meet all of the following conditions:

  • it must be the individual’s intention for the gifts to form a pattern; and
  • the gift must be made out of income generated during the current tax year; and
  • any gifts must not reduce the donor’s standard of living.

If these gifts qualify for this exemption, they will not be caught by the seven year rule. However, upon the death of the donor, all gifts will be considered to ensure that they qualified for this exemption.

As this is an area that HMRC pays particular attention to upon the death of an individual, it is recommended that you seek professional advice before making your initial gift.

Do I need to pay Inheritance Tax on my home?

You can pass on your home to your spouse or civil partner when you die, and there's no Inheritance Tax to pay. However, it's worth noting that in addition to the standard nil-rate band, there is a residence nil-rate band (RNRB) of £175,000 (2022/2023 tax year) that can increase your tax-free threshold if you leave your home to your children (including stepchildren, adopted children, and foster children).

For further information on RNRB read our recent article Inheritance Tax Residence Nil Rate Band – do you qualify?

If you leave your home to another person in your will, its value will be included in the calculation of your estate.

How can I reduce the amount of Inheritance Tax paid?

Estate planning can help minimize the impact of inheritance tax. Various strategies can be employed to reduce the overall tax liability. Some options include:

  • leaving a legacy to charity
  • putting your assets into a trust for your heirs. It's important to note that different types of trusts have varying tax treatments and rules
  • leaving your estate to your spouse or civil partner
  • contributing to a pension instead of a savings account
  • regularly giving away up to £3,000 a year in gifts
  • making gifts out of regular income.

Get in touch

This article provides only a brief overview of IHT. Inheritance Tax can be complex, so seeking professional advice is advisable. Tax laws and regulations are subject to change, so it's crucial to consult with a professional or refer to the latest HMRC guidance for the most up-to-date and accurate information. To discuss your specific circumstances further, please get in touch with a member of Rickard Luckin’s Private Client Team.

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