Inheritance Tax in the UK: How It Works and What You Can Do

Inheritance Tax is often described as a tax paid only by the very wealthy. In practice, frozen allowances, rising asset values and forthcoming pension changes mean that more families need to understand how it works, even if they never ultimately pay it.

Inheritance Tax, usually shortened to IHT, is charged on the value of a person’s estate when they die, after deducting available allowances, exemptions, reliefs and liabilities. The standard rate is 40%, but it applies only to the taxable part of the estate rather than to everything a person owns.

Fewer than one in twenty UK deaths resulted in an IHT charge in 2023/24. That statistic can be reassuring, but it does not tell the whole story. The average bill among estates that did pay was £231,000, while annual IHT receipts reached £8.5 billion in 2025/26. With the main thresholds fixed until April 2031 and most unused pension funds due to enter estates from 6 April 2027, reviewing the position early is increasingly important.

This guide explains the current rules in plain English, shows how the main allowances fit together and outlines the planning routes families commonly consider. It is an overview rather than personal tax or financial advice.

Key points

• The standard IHT rate is 40% on the taxable value above the allowances available to the estate.

• The ordinary nil-rate band is £325,000. A further residence nil-rate band of up to £175,000 may apply when a qualifying home passes to direct descendants.

• Unused nil-rate bands can usually transfer between spouses and civil partners, potentially allowing a qualifying couple to pass on up to £1 million before IHT.

• The residence nil-rate band is reduced once an estate exceeds £2 million, and this test is applied before Business Relief and most other reliefs are deducted.

• Gifting, trusts, insurance and Business Relief can all play a role, but each has different timeframes, trade-offs and risks.

What is Inheritance Tax and who pays it?

IHT is normally paid from the estate by the executors or administrators before assets are distributed to beneficiaries. A beneficiary does not usually pay tax simply because they inherit money or property, although later income or gains on inherited assets can create separate tax liabilities.

The estate generally includes property, cash, investments, personal possessions, business interests and certain gifts made during lifetime. Life assurance proceeds may also be included if the policy has not been placed in an appropriate trust. From 6 April 2027, most unused pension funds and pension death benefits will also be included for IHT purposes, subject to the detailed rules and exceptions.

The main Inheritance Tax allowances for 2026/27

The amount that can pass without IHT depends on the assets, the beneficiaries and what happened when a spouse or civil partner died. The main allowances are:

Allowance or rule	Current amount	How it works
Nil-rate band	£325,000 per person	Available against most assets. Any unused percentage can usually transfer to a surviving spouse or civil partner.
Residence nil-rate band	Up to £175,000 per person	May apply when a qualifying home passes to direct descendants. It cannot exceed the value of the qualifying home.
Couple’s potential combined bands	Up to £1 million	Potentially £650,000 of ordinary nil-rate bands plus £350,000 of residence nil-rate bands, if all conditions are met.
Standard IHT rate	40%	Applied to the taxable amount above the allowances.
Charitable reduced rate	36%	May apply to the relevant part of an estate when at least 10% of the net estate is left to charity.

How the residence nil-rate band can be lost

The residence nil-rate band is not an automatic extra £175,000 for every estate. A qualifying residential interest must pass to direct descendants, such as children, grandchildren, stepchildren or certain foster children. The allowance is also tapered by £1 for every £2 that the estate exceeds £2 million.

Crucially, the £2 million test looks at the estate after liabilities but before spouse exemption, charity exemption, Agricultural Relief or Business Relief. A large holding that qualifies for Business Relief can therefore still cause some or all of the residence nil-rate band to be lost.

Example: a straightforward calculation

A single person leaves an estate worth £900,000, including a £450,000 home left to an adult child. Assuming the full £325,000 nil-rate band and £175,000 residence nil-rate band are available, £500,000 is covered. The remaining £400,000 is taxed at 40%, producing an indicative IHT bill of £160,000. Real estates may have debts, gifts, exemptions or reliefs that change the result.

Why more families are reviewing IHT now

The nil-rate band has remained at £325,000 since 2009/10. The residence nil-rate band has been £175,000 since 2020/21, and both are now scheduled to stay fixed until 5 April 2031. When house prices, investments and business values rise while allowances remain unchanged, more estates can drift into the IHT net without the family feeling materially wealthier.

The pension changes from April 2027 are another reason to update older estate plans. Pensions have often been treated as a separate, tax-efficient asset to preserve for beneficiaries. Once most unused funds are included in the IHT calculation, drawing income, gifting from other assets, insurance and investment strategy may need to be reconsidered together rather than in isolation.

HMRC’s latest liability statistics show that 4.72% of UK deaths produced an IHT charge in 2023/24, the highest proportion since 2006/07. The average effective rate paid by taxpaying estates was 13%, not 40%, reflecting the value of allowances, exemptions and reliefs. This is an important reminder that planning is usually about structuring the estate properly, not pursuing one dramatic tax solution.

How Inheritance Tax is paid and why liquidity matters

An estate can have a manageable tax calculation but still face a difficult cash-flow problem. Inheritance Tax is generally due by the end of the sixth month after the month of death, with interest normally charged after that point. In many cases, at least some of the tax must be paid before the executors can obtain the grant of probate needed to collect or sell the estate’s assets.

That timing can create a circular problem where most of the wealth is tied up in property, a private company or other illiquid assets. HMRC’s Direct Payment Scheme can allow money held with participating banks, building societies and certain investment providers to be sent directly to HMRC before probate. Executors may also be able to use an executor’s loan, life assurance proceeds held in trust or other available cash, but the cost and practical implications need to be considered in advance.

For certain assets, including land, buildings, qualifying business interests and some shares, the tax may be paid in ten annual instalments. The first instalment is still due by the normal deadline, and selling the asset usually accelerates the outstanding balance. From 6 April 2026, HMRC guidance provides that instalments attributable to property qualifying for Agricultural Relief or Business Relief can be paid without interest on the outstanding balance, although late instalments can still attract interest.

Seven practical areas to consider

1. Make sure the will matches the tax plan

A well-drafted will determines who receives the estate and can preserve valuable allowances. Assets passing to a spouse or civil partner are normally exempt, and unused nil-rate bands can often be transferred to the survivor. By contrast, an unmarried partner does not receive the same automatic spouse exemption, regardless of how long the couple has lived together.

The will should be reviewed after marriage, divorce, a house move, the sale of a business or a significant change in wealth. It should also be consistent with pension nominations, life assurance trusts and shareholder arrangements.

2. Use lifetime gift exemptions deliberately

Each person can normally give away £3,000 per tax year using the annual exemption, with one year’s unused allowance capable of being carried forward. Separate exemptions cover small gifts of up to £250 per person and wedding or civil-partnership gifts of up to £5,000 to a child, £2,500 to a grandchild or great-grandchild and £1,000 to another person.

Regular gifts from surplus income can be especially valuable because there is no fixed monetary limit. To qualify as normal expenditure out of income, the gifts should form a pattern, be made from income and leave the donor able to maintain their usual standard of living. Records of income, expenditure and gifts are essential.

3. Understand the seven-year rule properly

Most outright gifts to individuals become fully outside the estate if the donor survives seven years. If death occurs sooner, the gift may use some or all of the nil-rate band. Taper relief can reduce tax on the gift after three years, but it does not reduce the value of the gift that uses the nil-rate band.

Giving away an asset while continuing to benefit from it usually fails. For example, transferring a home to children while continuing to live there rent-free is normally a gift with reservation and the property remains within the estate.

4. Consider trusts for control, not as a universal tax shortcut

Trusts can help protect assets, control when beneficiaries receive money and provide for vulnerable family members. They can also create immediate, ten-yearly and exit IHT charges, depending on the type of trust and the value transferred. The right structure depends on the family objective, not simply on whether a trust sounds tax-efficient.

5. Review pensions before April 2027

For deaths on or after 6 April 2027, most unused pension funds and death benefits will be brought into the estate for IHT. Existing beneficiary nominations remain important because pension benefits can still pass outside the will, but the value may affect the estate’s IHT calculation. Anyone whose previous plan was to spend taxable assets first and preserve the pension should revisit that logic.

6. Use life assurance to fund a liability, where appropriate

A whole-of-life policy can provide cash to help beneficiaries or executors meet an anticipated IHT bill. It does not reduce the liability itself. The policy will often need to be written in trust so that the proceeds are not added to the taxable estate and can be paid without waiting for probate. Premium affordability, underwriting and the long-term cost of cover all need careful assessment.

7. Explore Business Relief where the timeframe and risk fit

Business Relief can reduce the value of qualifying business interests when IHT is calculated. It can apply to a family trading business or to shares in qualifying unquoted trading companies. In many cases the asset must have been owned for at least two years and still qualify at the relevant time.

From 6 April 2026, the 100% rate is limited to a combined £2.5 million allowance for qualifying agricultural and business property. Unused allowance may transfer from a spouse or civil partner, potentially increasing the total to £5 million. Qualifying value above the allowance generally receives 50% relief. Certain shares, including qualifying AIM shares, now receive 50% relief rather than using the 100% allowance.

For investors, the attraction is that a qualifying investment may offer a shorter planning period than an outright gift while the investor retains ownership. The trade-off is investment risk. Unquoted investments can fall in value, may be difficult to sell and can cease to qualify. Relief is assessed under the rules at the relevant time and cannot be guaranteed.

A sensible starting process

A useful first step is to create a current estate schedule. Include property, cash, investments, pensions, business interests, life policies, debts and material gifts made in the previous seven years. Then model the position today and after a reasonable period of growth.

The next question is not simply, ‘How do we reduce IHT?’ It is, ‘How much capital might we need during life, what do we want beneficiaries to receive, how much control do we want to retain and which risks are acceptable?’ Those answers determine whether gifting, insurance, trusts, Business Relief or a combination is appropriate.

Inheritance Tax planning is rarely a one-off exercise. Reviews should take place after significant family or financial changes and whenever tax legislation changes.

Frequently asked questions

What is the Inheritance Tax threshold in 2026/27?

The ordinary nil-rate band is £325,000. A residence nil-rate band of up to £175,000 may also apply when a qualifying home passes to direct descendants. Unused bands can often transfer between spouses or civil partners, potentially giving a qualifying couple total bands of up to £1 million.

Is Inheritance Tax charged at 40% on the whole estate?

No. The 40% rate is normally applied only to the taxable value remaining after liabilities, exemptions, reliefs and the available nil-rate bands.

Can I give my house to my children and continue living there?

Usually not without the house remaining in your estate. Continuing to benefit from an asset after giving it away is generally treated as a gift with reservation unless full market rent and other conditions are met.

Do I have to survive seven years for Business Relief?

The usual Business Relief ownership period is two years, not seven, but the asset must qualify and generally remain qualifying at the relevant time. Separate rules can apply to gifts of business property.

Will pensions be subject to Inheritance Tax?

From 6 April 2027, most unused pension funds and pension death benefits will be included in the estate for IHT purposes. Detailed exceptions and administration rules apply.

How often should an estate plan be reviewed?

At least after major changes such as marriage, divorce, bereavement, a house move, business sale, retirement or a substantial change in assets. It should also be checked after Budgets and tax-law changes.

How Albatross Invest can help

Business Relief is one of several estate-planning tools. Albatross Invest provides access to a professionally managed investment approach focused on qualifying trading activity and asset-backed lending. The suitability of this route depends on the investor’s objectives, capacity for loss, liquidity needs and wider estate plan.

Where you already have a financial adviser, speak to them about how Business Relief may fit within your plan. Where you do not have an adviser, contact us to discuss the information and professional support available.

Important information

This article is for information only and does not constitute financial, investment, legal or tax advice. Tax treatment depends on individual circumstances and may change. Business Relief is assessed by HMRC and cannot be guaranteed. Investments in unquoted companies can fall in value, may be difficult to sell and can result in a loss of capital.