A baker’s dozen of things you should know about inheritance tax

• In 2022/23, 31,500 estates were liable for inheritance tax (IHT) at death, according to HMRC figures
• The number of estates paying IHT at death is expected to jump in 2027/28 − 10,500 estates which did not previously have an inheritance tax liability will have to pay IHT, as pensions enter the IHT net from next April
• To avoid your estate paying more IHT than it needs to, or falling foul of the rules by accident, it’s worth grasping some of the finer points

Sarah Coles, head of personal finance at AJ Bell, comments:

“Inheritance tax is positively Byzantine in its complexity, so while most people have got to grips with some of the basics, there will be a myriad of rules they have no idea at all about.

“Some of these will be niche areas that only the most dedicated of tax nerds will delve into. It’s why it can be incredibly helpful to have a professional to guide you through the process. But in any case, there are some incredibly useful things to know when you’re planning ahead.

1. Everything you leave to your spouse is free of IHT

“This applies to married couples and civil partners, and covers everything they own.

2. You may have two nil rate bands

“For anything you leave to someone other than your spouse or civil partner, up to £325,000 can be passed on free of IHT using your nil rate band. You may also have the £175,000 residence nil rate band, which applies if you give your main home to your direct descendants – most commonly children or grandchildren, but this also includes step-children and adopted children. It means you can leave up to £500,000 without worrying about tax. If your home is worth less than £175,000, then you only get the slice of the allowance you need to protect your home, and the rest is lost.

3. You can use your spouse’s unused nil rate band

“If you’re married or in a civil partnership, when the second of the couple dies, their estate can use any of their partner’s remaining nil rate bands. If the first of the couple to die leaves everything to their surviving spouse, it will all be available, so the first £1 million of their estate could be free of inheritance tax.

4. You have some allowances for gifts

“You have an annual gift allowance of £3,000 a year that you can give to anyone and it comes out of your estate immediately for IHT purposes. You can also carry forward this allowance for one year. You can give up to £250 to any number of people too – although not to anyone who has received money through the annual gift allowance. You can also make specific gifts for weddings – although the amount depends on who is getting married.

5. You can give larger lump sums

“You can give away lump sums of any kind, and they’ll fall out of your estate after seven years. These are known as potentially exempt transfers (PETs). However, if you die within seven years, there may be tax to pay. Anything you give away will be brought back into your estate and will first use up the nil rate band, so there’s less left for the rest of your estate. If you’ve made gifts that total over £325,000, then they’ll be brought back in, in chronological order, until the whole of the nil rate band is used up.

“Any gifts that breach the band will be liable to inheritance tax – and it’s the person who received the gift who will pay. Depending on how long ago it was given, taper relief might apply. If it was less than three years ago, there’s no taper, whereas if it was given 6-7 years ago they’ll pay 8% instead of 40%. If you’ve used a trust to make these gifts, the rules are more involved.

6. You can give gifts from surplus income – as long as you follow the rules

“Once you meet your usual living expenses, you can give away income that’s left over. However, this money needs to come from actual income – like earnings, pensions, rent, interest or dividends. You can’t use savings or investments for this. Nor can you live off your savings and give away income – you have to use your income to cover your own needs first.

“You also need to establish a regular pattern of gifts and keep specific records – including details of the regular gifts, the recipient, where the money is coming from, your usual expenses and the surplus income you have. It’s useful to complete HMRC’s IHT403 form as you go, so your personal representative dealing with your estate has the information they need. If you find any of this process daunting, it can be a good idea to get support from a financial adviser. They can also help you calculate what you can afford to give away.

7. Junior ISAs can be useful homes for gifts

“Parents can invest on behalf of a child under the age of 18 through a Junior ISA, which they will get access to when they turn 18. Although grandparents cannot set up or manage the account, they are free to make gifts to the Junior ISA for a parent to look after. The advantage is that it counts as being given away immediately – so is either part of annual gifting, regular gifts from income or starts the clock on a PET. However, the money remains tied up until they’re 18 and in a better position to make an adult decision about what to do with the money.

8. The rules around IHT on pensions are changing next April

“From next April, pensions will be drawn into the inheritance tax net, and unspent defined contribution pension pots will be added to the value of the estate, when IHT is being calculated. This is expected to drag another 10,500 estates into the inheritance tax net that year, hike the amount of tax paid by 38,500 estates and increase the tax due by £34,000 each on average.

“The personal representative dealing with the estate will also be responsible for making sure any IHT liability arising from the pension is paid. Where the pension isn’t going to a spouse, civil partner or charity, they can put a withholding notice on the scheme meaning the pension has to hold back distributing 50% of the value to cover potential IHT liabilities. It could mean delays on families getting all their funds until the IHT is paid, the notice is withdrawn or 15 months after death.

“It didn’t have to be this way. The industry proposed two much easier alternatives. All death benefits could have been subject to income tax, or alternatively, a standalone flat rate ‘inheritable pension tax charge’ could be paid on all unused pension funds and defined contribution lump sum death benefits above a threshold. These measures could have raised the same amount of money for government coffers without creating distress for vulnerable grieving families by piling on complex administration and delaying payments out of pension funds.

9. If you give money to charity, you can reduce your IHT bill

“Gifts during your lifetime to UK registered charities are free from IHT. This also applies to charity legacies you leave on death. You can also reduce the overall rate of IHT that applies on your taxable estate if you leave at least 10% of what’s known as your ‘net estate’ to charity.

“Your net estate is your total estate, minus any nil rate bands available. If the charitable legacies are more than 10% of this net estate value, their value is deducted to give your taxable estate – which will then be taxed at 36% instead of the headline rate of 40%. From 6 April 2027 unused pensions will be included in the net estate value when working out if the 10% minimum is met.

10. If you invest in qualifying AIM shares, there’s an IHT-break

“As long as you have held these shares for at least two years, then if there’s any inheritance tax to pay on them, it will be charged at 20% instead of 40% - as part of business property relief. However, it tends to be the smaller and newer company shares that qualify, which will come with a higher degree of risk, so they should only be considered as a small part of a large diverse portfolio if they suit your needs. It’s worth noting that this relief won’t apply to any AIM shares that are held in a pension on death after next April.

11. You can use life insurance to cover an expected tax bill

“You can use life insurance to pay out on death, leaving enough money to cover the tax bill. For this to work, it should be written in trust, so it is paid out to beneficiaries outside the estate. This means they don’t have to wait for probate to access it, and it doesn’t end up adding to the inheritance tax bill.

12. The tax has to be paid within six months

“Inheritance tax has to be paid within six months of the end of the month the person died in. HMRC charges interest on any tax paid late. In April 2025, the late payment interest was raised to 4% above the Bank of England base rate.

13. The tax has to be paid before you can get probate

“You might be able to pay this using savings or investments in the estate. If a major chunk of the estate is tied up in property, you can’t sell it until you have probate, so you might be able to apply to postpone at least part of the payment – although you will have to pay out any savings or investments in the estate to the taxman to cover part of the bill.

“To be allowed to postpone payment until a property is sold, there has to be an accepted offer in place and an estimated date for exchange of contracts. In the interim, there will be interest due on the outstanding tax. If you own a property in your pension, the option to postpone payment while it is sold will not be available.”