Understanding Inheritance Tax: A Comprehensive Guide

Inheritance tax (IHT) can significantly impact the value of the assets you leave behind for your heirs. If you are planning to transfer your estate after your death, it’s crucial to understand how IHT works, including rates, thresholds, and potential exemptions.

What is Inheritance Tax?

When you pass away, your heirs may face a tax bill of up to 40% on your estate. Your estate consists of your properties, savings, and various assets, minus any debts or funeral expenses. Fortunately, there are ways to reduce or even eliminate your inheritance tax liability, such as utilizing tax-free allowances and making lifetime gifts.

Inheritance Tax Thresholds and Rates for 2025-26

For the tax year 2025-26, each individual has a tax-free inheritance tax allowance of £325,000, commonly referred to as the nil-rate band. This threshold has remained unchanged since 2010-11.

Standard Rate

The standard inheritance tax rate is 40% on the value of your estate exceeding £325,000. For example, if your estate is valued at £500,000, the taxable amount would be £175,000, leading to a potential tax bill of £70,000 (40% of £175,000).

Additional Allowances

If you are married or in a civil partnership, you may benefit from an increased allowance, allowing you to transfer your unused allowance to your surviving partner. Additionally, since April 2017, an extra tax relief of £175,000 is available if you leave your property to a family member.

These allowances will remain frozen until 2030, as announced in the 2024 Autumn Budget.

Are Inherited Pensions Subject to Inheritance Tax?

Historically, pensions did not contribute to the estate for IHT purposes. However, from April 2027, unspent pension pots will be included in the estate for inheritance tax calculations.

Calculating Your Inheritance Tax Bill

Estimating your potential inheritance tax bill can be complex but necessary. Utilizing an inheritance tax calculator can aid you in determining how much tax you may owe based on your estate’s value.

Do Spouses Pay Inheritance Tax?

For married couples and civil partners, most transfers of wealth can occur tax-free. Surviving spouses can utilize both of their tax-free allowances. In 2025-26, couples can leave an estate worth up to £650,000 or £1 million if it includes a home, without incurring inheritance tax.

What Happens If I Remarry?

If you remarry after the death of your spouse, you can still claim the unused IHT allowance from your deceased partner. However, you cannot inherit the unused allowance from a new partner if you have already claimed one from your first spouse.

Can Spouses Inherit ISAs Tax-Free?

Any ISA funds are included in your estate upon death, but surviving spouses can benefit from the associated tax advantages. Since December 2014, bereaved spouses can reinvest their partner’s ISAs, enabling growth tax-free via an Additional Permitted Subscription (APS).

Gifts and Other Ways to Avoid Inheritance Tax

Several methods exist to mitigate inheritance tax, including:

• Gifts: Many gifts between spouses and to charities are tax-free.
• Potentially Exempt Transfers (PETs): Gifts made more than seven years before death can often escape tax.
• Trusts: Placing life insurance in a trust or employing a deed of variation in your will can also help in managing your IHT bill.

Who Pays the Inheritance Tax Bill?

Typically, the inheritance tax owed is paid from the deceased’s estate. Heirs must settle the tax within six months of the death, and it’s essential to apply for an inheritance tax reference number from HMRC in advance.

In cases where gifts made within the previous seven years incur tax, the recipients usually bear the responsibility unless they are unable or unwilling to pay.

Do You Need to Report the Value of the Estate?

Not all estates must report their value. Many may qualify as “excepted estates,” which can simplify the process.

Exceptions for Estates

• If a person passed away on or before December 31, 2021: Estates valued under the inheritance tax threshold or those left entirely to a spouse or UK charity may not require reporting.

• If a person passed away on or after January 1, 2022: Different conditions apply, and you may not need to report estates valued under £650,000 or those left entirely to a spouse or charity under certain conditions.

To learn more about inheritance tax, tax-free gifts, and estate management strategies, visit our resource guides.

By understanding the complexities of inheritance tax, individuals can make informed decisions to protect their heirs from unnecessary tax burdens, ensuring a smoother transition of wealth. Seeking expert advice or consulting professionals in estate planning can provide tailored solutions for your unique situation.