Inheritance Tax explained

Inheritance Tax (IHT) is charged on an estate when someone dies. It’s a tax on the value of everything owned — home, savings, investments and possessions — minus debts and funeral costs. Most estates pay nothing, because the nil-rate band covers a large amount before any tax is due.

The nil-rate band

Each person has a nil-rate band of £325,000. The first £325,000 of an estate is tax-free; everything above it is taxed. Because assets passed to a spouse or civil partner are exempt, their unused nil-rate band is transferred too — a married couple can effectively shelter £650,000.

The residence nil-rate band

If your main home passes to direct descendants — children, grandchildren or step-children — an extra residence nil-rate band of up to £175,000 applies. Combined with the nil-rate band, a single person can pass on up to £500,000 tax-free, and a married couple up to £1 million, when a home is left to their family.

The residence band is tapered by £1 for every £2 of estate over £2 million, so it disappears entirely for the largest estates.

The rates

The part of an estate above the allowances is taxed at 40% — or 36% if at least 10% of the taxable estate is left to charity.

Example. An estate is worth £500,000, of which a £300,000 main home passes to the children. The nil-rate band covers £325,000 and the residence band covers £175,000, because the home is worth more than the band. Total tax-free: £325,000 + £175,000 = £500,000 — so the bill is £0.

The big timing rule: seven years

Gifts made during your lifetime can reduce the estate, but only gifts made more than seven years before death are completely out of the picture. Gifts closer to death are added back, with taper relief reducing the tax after the third year.

See the maths

Use the Inheritance Tax calculator to estimate the bill on your estate, and the Capital Gains Tax calculator for the tax that may arise when assets are sold before the estate is distributed.