Inheritance tax and protecting your estate

Inheritance tax is a tax on what you leave behind. It is charged at 40 per cent, but only on the part of your estate that sits above your allowances. Nothing is charged on the allowances themselves.

Your estate means everything you owned on the day you died. The house, the savings, the investments, the car, the possessions, any business interest, less your debts and your funeral costs. Certain gifts you made in the seven years before your death are added back in, which is where a good deal of the complication comes from.

The tax is paid out of the estate by your personal representatives before anything is distributed, not by the beneficiaries out of what they receive. It has to be paid within six months of the end of the month in which you died, and in most cases before the grant of probate can be issued at all.

There is a reduced rate. Where at least a tenth of the net estate passes to charity, the rate on the rest drops from 40 per cent to 36 per cent. For estates already close to that mark, giving a little more to charity can leave the family no worse off, and sometimes better off.

It is worth keeping the scale of this in proportion. The clear majority of estates in this country pay no inheritance tax whatsoever. The number that do is rising, mainly because house prices have risen while the allowances have not, and that is the reason people who never expected to think about this are now thinking about it.

There are two allowances and they behave differently.

The nil rate band is £325,000 and everybody has it, whatever they own and whoever they leave it to. It has stood at that figure since 2009 and it is currently frozen until April 2030.

The residence nil rate band is a further allowance of up to £175,000. It is not automatic. It applies only where you owned a home and it passes on your death to your direct descendants, meaning children, stepchildren, adopted children, foster children and grandchildren. Leave the house to a brother, a niece or a friend and the allowance is not available. It is also reduced by £1 for every £2 by which your estate exceeds £2 million, so larger estates lose it altogether.

The part that does the heavy lifting is transferability. Anything you leave to your husband, wife or civil partner is exempt from inheritance tax, and any allowance you did not use passes to them. When they later die, their personal representatives can claim your unused nil rate band and your unused residence nil rate band on top of their own. Two full sets of allowances is £1 million.

That claim is not made for you. It has to be claimed on the second death, with evidence from the first, and the first death may have been thirty years ago. Keeping the death certificate, the will and the probate papers from a first death is one of the highest value pieces of admin a family will ever do.

If you sold the family home and moved into something smaller, or into care, you may still get the residence allowance through the downsizing addition, provided the value that came out of the house passes to your direct descendants. It is fiddly and it is regularly missed.

Giving things away is the oldest and simplest way of reducing an inheritance tax bill, and there are two separate systems for it.

The first is a set of exemptions you can use every year without any waiting period at all. You can give away £3,000 a year in total, and if you did not use last year's allowance you can carry it forward for one year only. You can give £250 a year to as many individual people as you like, provided they have not benefited from your £3,000. You can give wedding gifts of £5,000 to a child, £2,500 to a grandchild and £1,000 to anybody else. Gifts to your husband, wife or civil partner and to charities are exempt without limit.

There is a further exemption that is far more powerful than any of those and far less used. Regular gifts made out of surplus income, rather than out of capital, are exempt immediately and without any cap. The gifts have to form a pattern, they have to come from income, and they must not reduce your standard of living. If you can afford to pay a grandchild's school fees every term out of your pension and still live as you did, that money leaves your estate at once. It depends entirely on keeping records at the time, so start a simple schedule of income, outgoings and gifts on the day you begin.

The second system is the seven year rule. Any other gift you make is a potentially exempt transfer. Live seven years from the date you make it and it falls out of your estate completely. Die within seven years and it is added back in, and it uses up your nil rate band before the rest of your estate does.

Taper relief is widely misunderstood. It reduces the tax on the gift, not the value of the gift, and it only bites where the gift itself exceeds the nil rate band. For most families making ordinary gifts, surviving three years changes nothing at all. It is seven years or it is not.

One trap outranks all the others. If you give something away but carry on enjoying it, it is a gift with reservation of benefit and it stays in your estate however long you live. Signing the house over to your children and continuing to live in it rent free is the classic example. It achieves nothing for inheritance tax, it exposes the house to their divorce, their bankruptcy and their creditors, and it can create a capital gains tax bill that would never have arisen.

This is the biggest change in this area for a generation and it deserves its own section.

Until now, money left in a pension when you die has generally sat outside your estate for inheritance tax. That has made pensions an unusually efficient thing to pass on, and a great deal of planning over the last decade has been built on it, with people drawing on their other savings first and leaving the pension untouched.

From 6 April 2027 that is due to change. Unused pension funds and death benefits are expected to be brought into the estate and taxed with everything else. A family that has always assumed the pension would pass on free of inheritance tax may find that the estate crosses the threshold for the first time because of it.

Two consequences follow. The first is for anyone who has deliberately preserved a pension pot to pass on. The arithmetic behind that decision changes, and it is worth revisiting with a financial adviser well before the date rather than after it. The second is for executors, who will have to identify pension funds, obtain values from the schemes and account for the tax on them as part of the estate.

If you are close to the threshold and a pension is a large part of what you own, this is the single most important thing on this page for you. Do not leave it until 2027 to look at it.

Business property relief and agricultural property relief have long allowed qualifying trading businesses, farmland and certain shareholdings to pass with substantial relief from inheritance tax, in many cases at 100 per cent.

That has changed. From April 2026 the amount that qualifies for relief at 100 per cent is capped, with the value above the cap relieved at a lower rate instead. Shares quoted on the Alternative Investment Market are also treated less generously than they were. Families who built a succession plan on full relief, in particular farming families and owners of long established trading companies, may now face a real liability where they were told there would be none.

If you own a business, a farm, a share in a partnership or a significant holding in an unquoted trading company, take this as a prompt to have the plan looked at again. The reliefs are technical, the qualifying conditions are strict, and the difference between an asset that qualifies and one that does not is often a matter of how the business is structured rather than what it does.

The instalment option matters here too. Inheritance tax attributable to land, to a business and to certain shareholdings can be paid in ten equal annual instalments rather than in one sum, which can be the difference between a family keeping a business and having to sell it to pay the tax.

Sometimes, and less often than the people selling trusts would have you believe.

A trust separates the legal ownership of an asset from the benefit of it. Trustees hold it, and the beneficiaries enjoy it, on the terms you set. That is genuinely valuable in a handful of situations. Money for a child who is too young to handle it. Provision for a disabled family member whose means tested benefits a lump sum would destroy. Giving a second husband or wife the right to live in the house for life, with the house then passing to your own children rather than to their family. Holding a life insurance policy so that the payout goes straight to your family and never forms part of your estate at all, which is simple, cheap and almost always worth doing.

What a trust is not is a general purpose way of making inheritance tax disappear. Most lifetime trusts fall into what is called the relevant property regime. Putting more than the nil rate band into one can trigger a charge on the way in. There is a charge on every tenth anniversary, and a charge when money comes out. Trusts have to be registered, they file their own tax returns, and they cost money to run for as long as they exist.

Be careful about who is offering. There is a persistent market in so called asset protection trusts and family protection trusts, sold at seminars and in living rooms, promising to shelter the family home from care fees and inheritance tax. Many of them are sold by unregulated firms, many of them do not work, and some of them leave the family worse off than doing nothing. Both the Solicitors Regulation Authority and the Law Society have warned about them.

The test is simple. If somebody is selling you a trust as a product, without asking in detail about your family, your income and what you want to happen, be suspicious. A trust is a tool for a specific problem. Find the problem first.

This is the question we are asked most often, and the honest answer is not the one people want.

If you need residential care, the local authority carries out a financial assessment. Where your capital is above the threshold you pay for your own care, and the value of your home is usually taken into account unless a husband, wife, partner or certain relatives still live there.

Giving the house away to avoid that is called deprivation of assets. If the local authority decides that avoiding care fees was a significant reason for the transfer, it can assess you as though you still owned the house. There is no seven year rule here and no time limit at all. A transfer made twenty years ago can be looked at, and the authority can pursue the person who received the property.

There is also a great deal to lose. A house in your children's names is exposed to their divorce, their bankruptcy and their creditors. You may lose the capital gains tax exemption that would have applied on your own home. You may create an income tax charge on yourself under the pre owned assets rules. And you no longer own the roof over your head.

Something more limited does work, and it is worth knowing. A couple who own their home as tenants in common can each leave their half share on trust, giving the survivor the right to live there for life while ring fencing the deceased's half for the children. If the survivor later needs care, only their own half is assessed. It is a well established arrangement, it needs the ownership of the house changed as well as the wills written, and it is one of the few things in this area that does what it says.

Anyone who tells you they can put your house beyond the reach of care fees entirely is either mistaken or selling you something. Ask them to put the promise in writing and watch what happens.

Ordinary, unglamorous things, done early and written down.

Make a will. Nothing on this page functions without one. The residence nil rate band depends on where the house goes, the transferable allowances depend on how the first death is dealt with, and the charity rate depends on a clause in the document.

Work out what you are actually worth, including the pension, and check whether you are anywhere near the threshold at all. Most people are not, and finding that out will save you from paying for planning you do not need.

Leave everything you can to your husband, wife or civil partner outright, so that the allowances transfer, unless there is a reason not to such as children from a previous relationship.

Keep the paperwork from a first death. It is what allows the second estate to claim two sets of allowances.

Use the annual exemptions if you can afford to, and start a record of regular gifts made out of income. Both are free and both are routinely wasted.

Write life insurance in trust. It costs nothing extra at the point the policy is taken out and it keeps the payout out of your estate and out of the probate process.

Consider a charitable legacy if you are close to the ten per cent mark, because the reduced rate can make it nearly cost neutral.

Review it when the law changes. The pension change in 2027 and the changes to business and agricultural relief are exactly the kind of thing that turns a sound plan into an out of date one.

If your estate including the pension is comfortably below £325,000, or below £650,000 for a married couple, you probably need a well drafted will and nothing else. Say so to anybody who tries to sell you more.

It is worth taking advice if you are near or over the threshold, if you own a business, a farm or property abroad, if you have children from more than one relationship, if you want to provide for a disabled family member, if you are thinking about making a substantial gift, or if you have been offered a trust scheme by somebody who came to you.

Take it from someone regulated. A solicitor is regulated by the Solicitors Regulation Authority, carries compulsory professional indemnity insurance, and is answerable to the Legal Ombudsman. Estate planning is not a reserved legal activity, which means anybody can offer it, and a great deal of the poorest advice in this field comes from firms with no regulator at all.

Tax advice and investment advice are separate things again. We will tell you plainly where the answer belongs with an accountant or a financial adviser rather than with us, and we would rather do that than guess.

Start with a conversation. An hour spent working out whether you have a problem is worth more than any scheme, and for most families the answer is that a good will does the job.