Inheritance Tax Explained: A Plain-English Guide for Families

Inheritance Tax is one of the most confusing and anxiety-inducing aspects of dealing with someone's estate. Many families worry about it unnecessarily, while others are caught off guard by an unexpected bill. The truth is that the vast majority of estates in the UK do not end up paying any Inheritance Tax at all — but understanding how it works is still important.

This guide explains what Inheritance Tax is, who might have to pay it, and how the process works, all in plain English.

What is Inheritance Tax?

Inheritance Tax (IHT) is a tax on the estate of someone who has died. It's charged on the total value of everything the deceased owned — including property, savings, investments, and possessions — minus any debts they owed.

IHT is paid by the estate, not by the people who inherit. The executor or administrator of the estate is responsible for calculating whether IHT is due, reporting to HMRC, and paying any tax owed before distributing assets to the beneficiaries.

What is the Inheritance Tax threshold?

The standard IHT threshold — known as the nil-rate band — is £325,000. This means that the first £325,000 of an estate is tax-free. Anything above this threshold is taxed at 40%.

This threshold has been frozen at £325,000 since 2009 and is currently frozen until at least April 2028.

There is also an additional threshold called the residence nil-rate band, which applies when a home is passed to direct descendants (children or grandchildren). This adds an extra £175,000 to the threshold, bringing the potential tax-free allowance for a single person to £500,000.

Can the threshold be transferred between spouses?

Yes, and this is one of the most important reliefs available. When the first spouse or civil partner dies, any unused portion of their nil-rate band can be transferred to the surviving partner. This means that when the second partner dies, their estate can potentially benefit from a combined threshold of up to £650,000 (or £1,000,000 including both residence nil-rate bands).

This transferable allowance applies automatically in most cases, but the executor must claim it when reporting the estate to HMRC.

What is exempt from Inheritance Tax?

Several types of gift and transfer are exempt from IHT entirely. Anything left to a spouse or civil partner is exempt, with no upper limit. Gifts to UK registered charities are exempt. If you leave at least 10% of your estate to charity, the IHT rate on the rest is reduced from 40% to 36%.

Certain types of property, such as agricultural land and some business assets, may qualify for Agricultural Property Relief or Business Property Relief, which can significantly reduce or eliminate IHT on those assets.

Gifts made during your lifetime are generally exempt if you survive for seven years after making them. This is known as the "seven-year rule." Gifts made within seven years of death may be taxed on a sliding scale.

How do you calculate Inheritance Tax?

The basic calculation is straightforward. Add up the total value of the estate, including property at market value, bank accounts and savings, investments, life insurance payouts (unless held in trust), personal possessions (jewellery, cars, furniture, etc.), and any gifts made within seven years of death.

Then subtract debts (mortgage, credit cards, loans), funeral expenses, and any exempt transfers (gifts to spouse, charity, etc.). If the remaining amount is above the nil-rate band (plus any residence nil-rate band), IHT is charged at 40% on the excess.

When does Inheritance Tax need to be paid?

IHT must normally be paid within six months of the end of the month in which the death occurred. Interest is charged on any amount paid late.

In practice, this can create a cash flow problem for estates that include property — the tax may be due before the property is sold. HMRC allows IHT on property to be paid in annual instalments over ten years, though interest is still charged on the outstanding balance.

IHT on other assets (such as bank accounts) must usually be paid in full before the Grant of Probate is issued. Some banks will release funds directly to HMRC to pay the tax before the Grant is obtained, using a process called the Direct Payment Scheme.

Do you need to report to HMRC?

Most estates need to be reported to HMRC, even if no tax is due. The reporting requirements depend on the size and complexity of the estate. Smaller estates that fall below the thresholds and qualify for certain exemptions may be able to use a simplified reporting process. Larger or more complex estates will need to complete the full IHT return (IHT400).

Your solicitor (if you have one) will usually handle this. If you're administering the estate yourself, HMRC provides guidance on GOV.UK, and their Inheritance Tax helpline can answer specific questions.

How Passage can help

Inheritance Tax can feel overwhelming, but you don't have to navigate it alone. Passage helps UK families understand and manage the practical steps involved in settling an estate, including knowing when to seek professional advice on tax matters.

Start your free plan and let us help you through the process, one step at a time.