Inheritance tax is increasingly affecting families that would not traditionally have considered themselves wealthy. With the threshold frozen, rising property values, and a growing number of estates caught in the net, planning ahead has never been more important.
IMPORTANT
“Inheritance Tax Estate Planning and Trusts are not regulated by the Financial Conduct Authority”
Q: What is the current inheritance tax threshold?
A: The nil-rate band is £325,000 per person and has been frozen at that level since 2009. A married couple or civil partners can combine allowances, potentially sheltering up to £1 million including the residence nil-rate band, but property price growth means many London families now face a liability they had not anticipated.
Inheritance tax is charged at 40% on the value of an estate above the nil-rate band at the date of death. The standard nil-rate band is £325,000 per individual. Transfers between spouses and civil partners are exempt, which means an unused nil-rate band can be transferred to a surviving spouse, giving a combined threshold of up to £650,000.
The residence nil-rate band adds a further £175,000 per person where a main residence is left to direct descendants, giving a potential combined threshold of £1 million for married couples leaving their home to children or grandchildren. This band tapers for estates valued above £2 million.
Everything above the applicable threshold is taxed at 40%. A London family with a property worth £900,000 and other assets of £300,000 faces a total estate of £1.2 million. After allowances of £1 million, the IHT bill would be £80,000.
A couple in their 70s came to me last year with an IHT liability of 400,000. Thankfully they had a sufficient amount of liquidity which made it easier to gift money into trust – set up insurance policies to cover the 7 year clock and the remaining liability post gift. The real benefit asides from minimising their IHT Liability came from setting up an investment within a trust that could benefit their family on their terms for generations to come.
What assets are included in an estate for IHT purposes?
The estate includes all assets owned at death: property, investments, cash, business interests, vehicles, personal possessions and life insurance policies not written in trust. Some assets receive specific reliefs, but the starting point is the total value of everything owned.
Crucially, pension funds are generally outside the estate for inheritance tax purposes, which makes pensions an important planning tool. Under current rules, unspent pension funds pass to nominated beneficiaries free of inheritance tax, though income tax may be payable depending on the circumstances and how the beneficiary draws the funds.
From April 2027, proposed changes to pension taxation mean that unused pension funds will be brought within the scope of inheritance tax for deaths on or after that date. This is a significant shift that requires planning now for those with substantial pension funds.
What are the main exemptions and reliefs?
The annual gifting exemption allows each individual to give away up to £3,000 per year free of IHT. This can be carried forward one year if unused, giving a potential £6,000 in the first year of gifting. Gifts to charity, political parties and certain other bodies are also exempt.
Gifts from surplus income are potentially exempt where they are made regularly, from income rather than capital, and do not affect the donor’s standard of living. This exemption is particularly valuable for high earners who wish to pass wealth to family members during their lifetime.
Business Property Relief provides 100% relief on qualifying business assets, including unquoted shares and sole trader businesses. Agricultural Property Relief applies to qualifying farmland. AIM shares have historically qualified for Business Property Relief after a two-year holding period, though this relief was reduced to 50% from April 2026 for AIM holdings above £1 million.
Business Property Relief Schemes (BPR) and Alternative Investment Market (AIM) invest in assets that are high risk and can be difficult to sell such as shares in unlisted companies. The value of the investment and the income from it can fall as well as rise and investors may not get back what they originally invested, even taking into account the tax benefits.
A client with a high annual income wanted to start passing wealth to his children but was concerned about potential Inheritance Tax implications. After reviewing his finances, it was clear that his income comfortably exceeded his normal living expenses. We therefore structured a plan where he made regular gifts to his children each year from his surplus income. Because the gifts were made consistently, from income rather than capital, and did not impact his standard of living, they qualified as gifts from surplus income, allowing him to pass wealth to his family in a highly tax-efficient way during his lifetime.
How do potentially exempt transfers work?
A potentially exempt transfer is a gift made during lifetime that falls outside the annual exemptions. It becomes fully exempt from inheritance tax if the donor survives for seven years from the date of the gift. If the donor dies within seven years, the gift may be included in the estate, though taper relief reduces the IHT charge on gifts made more than three years before death.
The seven-year rule makes early planning particularly valuable. A gift made at 55 that is fully clear by 62 is far more useful than the same gift made at 68, where there is a much higher probability of dying within the seven-year window.
It is important to note that the donor must genuinely give away the asset. A gift with reservation, where the donor continues to benefit from the asset, does not count as a potentially exempt transfer. A parent who gives away their home but continues to live in it rent-free has not made an effective gift for IHT purposes.
What role do trusts play in estate planning?
Trusts can be used to remove assets from an estate while retaining a degree of control over how those assets are managed and distributed. A discretionary trust allows assets to be held for the benefit of a class of beneficiaries, with the trustees deciding how and when distributions are made.
Assets placed in trust are generally outside the estate for inheritance tax purposes after seven years, subject to ten-year anniversary charges and exit charges that apply to discretionary trusts. The tax treatment of trusts is complex, but for larger estates the potential savings can significantly outweigh the costs.
Life insurance policies can also be written in trust, ensuring that the payout goes directly to beneficiaries without forming part of the estate and without the delay of probate. This is a straightforward step that many people do not take simply through lack of awareness.
I’ve advised clients on using life insurance policies to help manage potential Inheritance Tax liabilities. In these cases, the policy is typically written in trust so that the payout does not form part of the individual’s estate, which would otherwise increase the IHT liability. By placing the policy in trust, the proceeds remain outside the estate and can be paid directly to beneficiaries, often providing the funds needed to cover any IHT due on the estate.
How do pensions interact with inheritance tax planning?
Pensions are currently one of the most powerful tools in estate planning. Because pension funds generally sit outside the estate, they are the last asset a financially comfortable person should draw down in retirement. Spending taxable assets first and leaving the pension intact can meaningfully reduce the eventual IHT liability.
However, as noted above, proposed changes taking effect from April 2027 will bring unused pension funds within the scope of inheritance tax. For those with substantial pension funds, reviewing the implications and adjusting drawdown strategy in advance is an important planning step.
The interaction between income tax, inheritance tax and pension planning has become considerably more complex as a result of these changes. What was the right strategy under the old rules may not be the right strategy from 2027 onwards.
What is the nil-rate band freeze costing families?
The nil-rate band has been frozen at £325,000 since 2009 and is currently set to remain frozen until at least April 2030. In the same period, UK house prices have roughly doubled.
The effect is that estates which would comfortably have been below the threshold 15 years ago are now significantly above it. This is particularly acute in London, where the average property price means that even relatively modest estates can face a liability.
HMRC receipts from inheritance tax have risen significantly as a result of this fiscal drag. The Office for Budget Responsibility has projected further increases in coming years as more estates are pulled into the net.
I recently worked with a client whose estate had grown significantly over the past decade, largely due to the increase in the value of their home. While their wealth would have comfortably sat below the Inheritance Tax threshold years ago, the continued freeze of the nil-rate band at £325,000 meant their estate was now well above it. Through careful planning, including the use of allowances and longer-term estate planning strategies, we were able to start reducing the potential future IHT liability and ensure more of the estate would ultimately pass to their family rather than to HMRC.
How does charitable giving affect IHT?
Gifts to charity are fully exempt from inheritance tax. In addition, if at least 10% of the net estate is left to charity in a will, the inheritance tax rate on the remainder reduces from 40% to 36%.
For those with charitable intentions, this interaction can make giving to charity considerably more tax-efficient than it might appear. In some cases, leaving money to charity can increase the net amount received by other beneficiaries, rather than reducing it, because of the reduced rate applied to the rest of the estate.
Charitable gifts made during lifetime also benefit from income tax relief under Gift Aid, making lifetime giving more tax-efficient in most cases than a legacy on death.
When should estate planning begin?
The honest answer is as early as possible. The seven-year clock on potentially exempt transfers means that every year of delay is a year of planning opportunity lost. For someone in their 50s, a structured gifting programme begun now could clear very significant amounts from the estate before the statistical point at which IHT becomes a live concern.
For those with illiquid assets, such as property or business interests, the planning window is even more important. Restructuring an estate around assets that do not easily lend themselves to gifting requires time, and rushed arrangements made close to death are more likely to be challenged by HMRC.
A financial plan that does not address estate planning is an incomplete plan for anyone with a meaningful estate. The cost of not planning is almost always higher than the cost of the planning itself.
What does a basic estate planning review involve?
A review starts with a clear picture of the current estate: all assets, their current value, how they are owned, and any existing structures or arrangements in place. From there, the projected IHT liability can be calculated under current rules and compared with the liability under proposed future rules.
The next step is identifying which assets are most suited to gifting or restructuring, and which exemptions and reliefs apply. A phased plan can then be built around the client’s goals, whether that is minimising tax, maintaining flexibility, or both.
Where trusts, business structures or pension arrangements are involved, coordinating the financial plan with a solicitor and, where appropriate, a tax adviser ensures that the overall strategy holds together. At Ark, we work alongside clients’ existing legal advisers or can refer to specialists where needed.
Frequently Asked Questions
Is there inheritance tax between spouses?
Transfers between UK-domiciled spouses and civil partners are fully exempt from inheritance tax. Any unused nil-rate band can also be transferred to the surviving spouse on death.
Can I give my house to my children to avoid IHT?
How long does IHT have to be paid after death?
What happens to my pension after I die?
Concerned about inheritance tax on your estate? Ark Wealth Management provides confidential estate planning reviews for London professionals and families. Visit arkwm.co.uk to arrange a confidential conversation. |
Risk Warning
The value of pensions and investments and the income they produce can fall as well as rise. You may get back less than you invested.
Financial Disclaimer
This article is for informational purposes only and does not constitute personalised financial advice. Tax rules and allowances are subject to change. The information contained here is based on current UK legislation and HMRC guidance. Past performance is not a guide to future performance. The value of investments can fall as well as rise and you may get back less than you invest. Ark Wealth Management is an appointed representative of Quilter Financial Services Ltd which is authorised and regulated by the Financial Conduct Authority. Always seek independent financial advice tailored to your personal circumstances before making financial decisions.