What is Inheritance Tax and how can I plan for it?

Inheritance Tax — IHT — is a charge on what you leave behind when you die. For most estates it's not payable at all; for those that do pay it, the headline rate is 40%, which gets attention. It's also one of the few taxes where forward planning genuinely changes the outcome, often dramatically.

How the thresholds work in 2025/26

Every individual has a 'nil-rate band' of £325,000. Anything in your estate above that is potentially taxable. On top of that, if you leave your main residence to direct descendants — children, grandchildren, stepchildren — you may also get a 'residence nil-rate band' of £175,000.

Married couples and civil partners can transfer any unused allowances to the surviving partner, so a couple can potentially pass on up to £1 million between them (two nil-rate bands plus two residence nil-rate bands) before any IHT is due — provided the residence is left to direct descendants. Both nil-rate bands are frozen until April 2030, which means more estates will drift into IHT as house prices and other assets grow. The residence nil-rate band also tapers away by £1 for every £2 of estate above £2 million.

The big change: pensions and IHT from April 2027

From 6 April 2027, unused defined contribution pensions are due to fall within the IHT regime for the first time. Until then, most pensions can be passed to beneficiaries free of IHT (and, in some cases, free of income tax too). After that date, unused pension funds will count towards your estate. For families with significant pension wealth, that's a material change — and one we'd encourage clients with larger estates to factor into planning now, not in 2027.

Tax treatment depends on individual circumstances and may be subject to change in future.

The main planning levers

Most IHT planning comes down to a small number of well-understood tools, used in combination:

• Spending it. The simplest planning of all — enjoying your money during your lifetime — reduces the eventual estate. Surprisingly often, retirees are over-saving and under-spending.
• Outright gifts. Gifts to individuals are 'potentially exempt transfers' — they fall outside your estate after seven years. Smaller annual exemptions also exist (£3,000 per year, plus £250 small gifts, plus wedding gifts) which leave the estate immediately.
• Gifts from surplus income. A less-known but powerful exemption: regular gifts made out of income (not capital) that don't reduce your standard of living are immediately outside your estate, with no seven-year wait.
• Trusts. Putting assets into trust can take them outside your estate over time, while keeping some control over how and when beneficiaries receive them. Trusts have their own tax regime and aren't right for every situation.
• Charitable giving. Gifts to charity are exempt from IHT, and leaving 10% or more of your net estate to charity reduces the IHT rate on the rest from 40% to 36%.
• Business and agricultural assets. Some business and farm assets qualify for Business Relief or Agricultural Relief, currently at 100% — though changes announced in the Autumn 2024 Budget will, from April 2026, cap full relief at the first £1 million of qualifying assets, with 50% relief above that.
• Life cover written in trust. A whole-of-life policy written in trust can provide a lump sum to pay the IHT bill, so the estate doesn't have to be partly liquidated to settle it.

The seven-year rule, in plain English

The most common question we get on IHT is about the seven-year rule. The principle is straightforward: no IHT is due on any outright gifts you give if you live for seven years after giving them — unless the gift is into a trust, which has its own rules. Survive the seven years and the gift falls outside your estate entirely.

If you die within seven years, the gift is added back into your estate. Gifts made in the three years before death are taxed at the full 40%; gifts made between three and seven years before death are taxed on a sliding scale known as 'taper relief'. Crucially, taper relief only applies if the total value of gifts made in the seven years before death is more than the £325,000 nil-rate band — gifts within the band don't benefit from taper, because there's no IHT on them in the first place.

Two important caveats. First, if a gift is made within seven years and there's still IHT to pay, the recipient is responsible for it — which can come as an unwelcome surprise if they've spent the money. Second, you can't 'gift' something while continuing to benefit from it (the so-called 'gift with reservation of benefit' rule). Giving your house to your children and continuing to live in it rent-free, for instance, doesn't take the house out of your estate.

Where it tends to go wrong

IHT planning fails most often not because the rules are too complex, but because nothing is done. Estates drift into IHT territory through house price growth and pension accumulation, and by the time anyone looks closely the simplest tools — outright gifts, regular gifts from income — have a smaller window to work in.

It also fails when planning is overdone in the wrong direction. Giving away too much too early can leave you exposed if circumstances change — care costs in particular can be expensive and unpredictable. The right plan is one that reduces the eventual IHT bill without compromising your own financial security or your independence.

When to start the conversation

The most useful time to start IHT planning is at least a decade before you'd expect it to bite — which, for most clients, means in the years approaching or just after retirement. That's when income and capital are usually settled, when children's circumstances are clearer, and when there's still time for the seven-year rule and other tools to work.

Even if you're closer to it than that, there's almost always something useful to do — particularly with gifts from surplus income, life cover in trust, and (from now until April 2027) thinking about how pensions fit into the estate.