4.4 UK Inheritance Tax

4.4 UK Inheritance Tax: An Introductory Guide

This chapter provides a plain-English introduction to how Inheritance Tax (IHT) works in the UK, including the significant changes to pension taxation taking effect from April 2027. It is designed to give you a working understanding of the rules - not to replace professional advice. If your estate is substantial, or your circumstances complex, a regulated financial adviser or solicitor should be your next step.

This guide assumes the pension IHT changes announced at Autumn Budget 2024 and confirmed in the November 2025 HMRC policy paper are implemented as planned from 6 April 2027. We will update this chapter if the rules change before or after that date.

1. What Is Inheritance Tax?

Inheritance Tax is a tax on the estate of someone who has died - that is, the total value of everything they owned, including property, money, investments and personal possessions. In most cases it is paid before any assets are passed on to beneficiaries.

The key facts at a glance:

• The standard IHT rate is 40%, applied only to the portion of the estate above the tax-free threshold.
• The basic tax-free threshold - called the nil-rate band - is £325,000.
• There is no IHT to pay if you leave everything above the threshold to your spouse, civil partner, a charity, or a community amateur sports club.
• IHT is usually paid by the executor from the estate's funds before assets are distributed. Beneficiaries do not normally pay tax on what they inherit.

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2. Your Tax-Free Thresholds

Most people can reduce - or even eliminate - their IHT liability through the thresholds and allowances described below.

The Nil-Rate Band (NRB)

Everyone has a basic nil-rate band of £325,000. Anything up to this amount passes free of IHT. Married couples and civil partners can combine their allowances: if the first partner to die doesn't use their full nil-rate band, the unused portion transfers to the survivor.

In practice, this means a married couple can pass up to £650,000 free of IHT - potentially more with the residence nil-rate band (see below).

The Residence Nil-Rate Band (RNRB)

If you own your home (or a share of it) and leave it to your children, stepchildren, adopted children, foster children, or grandchildren, your threshold increases by up to a further £175,000 per person. This is known as the residence nil-rate band.

Combined with the basic nil-rate band, a married couple where both have a home to pass on can benefit from up to £1 million in combined tax-free thresholds.

Important conditions:

• Your estate must be worth less than £2 million. Above this, the RNRB tapers away by £1 for every £2 over the threshold.
• The property must be passed to direct descendants (children, grandchildren) - not siblings, friends or other relatives.
• The RNRB is transferable between spouses in the same way as the nil-rate band.

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Reduced Rate for Charitable Giving

If you leave 10% or more of the net value of your estate to charity, the IHT rate on the remainder reduces from 40% to 36%. For larger estates, this can make charitable giving a tax-efficient element of estate planning - but the sums involved are worth checking with an adviser.

3. Gifts During Your Lifetime

IHT is not only charged on what you leave when you die. Gifts you make during your lifetime can also be brought back into your estate if you die within seven years of making them. However, there are important exemptions that allow you to give money and assets away free of any IHT charge.

Gifts That Are Always Exempt

• Gifts to your spouse or civil partner (provided they live in the UK permanently).
• Gifts to registered charities or political parties
• Wedding or civil partnership gifts: up to £5,000 to a child, £2,500 to a grandchild or great-grandchild, or £1,000 to anyone else

Annual Allowances

• Annual exemption: You can give away up to £3,000 per tax year, free of IHT, to one or more people. Any unused exemption can be carried forward one year only.
• Small gift allowance: You can give up to £250 to as many individuals as you like in a tax year - as long as you haven't used another allowance on the same person.
• Normal expenditure out of income: Regular payments made from your income - not capital - are exempt with no upper limit, provided they don't affect your normal standard of living. This could include regular financial support to a child, or contributions to a grandchild's savings.

The Seven-Year Rule

Larger gifts that fall outside the exemptions above are treated as 'potentially exempt transfers'. If you survive seven years from the date of the gift, no IHT is due. If you die within seven years, the gift is added back into your estate and may attract IHT - though the rate reduces the longer you survive after making the gift, thanks to taper relief.

Taper relief only applies if the total value of gifts in the seven years before death exceeds the £325,000 nil-rate band. The rates are:

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Gifts With Reservation

If you give something away but continue to benefit from it - for example, gifting your home to your children while still living there rent-free - this is treated as a 'gift with reservation' and remains part of your estate for IHT purposes. To avoid this, you would need to pay a full market rent and meet your share of the bills.

4. Passing on Your Home

Your home is usually the largest single asset in your estate, so understanding how it is treated for IHT is important.

• You can pass your home to your spouse or civil partner with no IHT due.
• Leaving your home to your children or grandchildren in your will qualifies it for the residence nil-rate band (see Section 2).
• If you give your home away during your lifetime and move out, there is normally no IHT to pay - provided you live for seven years after the gift.
• If you give your home away but continue living there without paying a market rent, it will count as a gift with reservation and remain in your estate (see Section 3).

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If you own your home jointly - as joint tenants - ownership automatically passes to the surviving owner on death, outside the estate entirely. If you own as tenants in common, your share forms part of your estate and can be left by will.

5. Business Relief and Agricultural Relief

Certain business assets can qualify for Business Relief (BR), which reduces or eliminates their value for IHT purposes. The relief is up to 100% for qualifying business interests and unlisted shares, or 50% for certain other business property. To qualify, assets must generally have been held for at least two years.

Agricultural Relief works similarly for qualifying farmland and agricultural property.

These reliefs are highly technical, have specific conditions, and are subject to government review. If your estate includes business interests or agricultural land, professional advice is essential.

6. Who Pays the Tax - and When

The executor named in your will (or an administrator if there is no will) is responsible for calculating and paying any IHT due to HMRC from the estate. This is done before assets are passed to beneficiaries, which can create a timing issue - assets may need to be sold to raise the funds.

IHT on the estate must generally be paid within six months of the end of the month in which death occurred. Tax on some assets, such as property, can be paid in annual instalments over ten years.

For gifts made in the seven years before death, any IHT due is normally paid by the estate - but if the gifts have already exceeded the nil-rate band, the recipients of later gifts may become personally liable.

7. Pensions and Inheritance Tax: The Significant Change from April 2027

This section is particularly important for RetirePlan users. Until now, most pension funds have sat outside your estate for IHT purposes - making them a highly tax-efficient way to pass wealth. From 6 April 2027, this changes fundamentally.

How It Worked Before April 2027

Under the rules in place before April 2027, most defined contribution pension funds - including drawdown pots - were held in 'discretionary' schemes outside your estate. This meant:

• Your pension pot was not counted when calculating IHT.
• Beneficiaries could inherit pension funds with no IHT charge, though income tax could still apply depending on your age at death.
• Many people were deliberately choosing to leave their pension untouched and draw on other assets first - a 'pensions last' strategy - specifically to minimise IHT.

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The government concluded that pension schemes were increasingly being used and marketed as tax planning vehicles rather than retirement income tools, and the 2024 Budget announced legislation to bring this to an end.

What Changes from 6 April 2027

From this date, unused defined contribution pension funds and certain pension death benefits will be included in the value of your estate for IHT purposes. This applies regardless of whether the pension scheme is discretionary or not.

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What Is Excluded from the Change

Not every pension-related payment is brought into scope. The following remain outside IHT after April 2027:

• Transfers to a surviving spouse or civil partner (the existing spousal exemption is maintained).
• Death in service benefits paid from a registered pension scheme.
• Dependants' scheme pensions from defined benefit or collective money purchase arrangements.
• Lump sum payments to registered charities.

The Scale of the Change

HMRC estimates that of around 213,000 estates with inheritable pension wealth in 2027/28, approximately 10,500 will face an IHT liability for the first time, and around 38,500 will pay more IHT than previously. The average additional IHT liability where pension assets are included is estimated at £34,000. (Source: HMRC Policy Paper - Inheritance Tax: Unused Pension Funds and Death Benefits, November 2025)

⚠️  Important note on double taxation

Where pension funds are included in your estate for IHT, income tax may also apply when your beneficiaries draw those funds - especially if you die after age 75. The government's changes have addressed the most acute double taxation scenarios, but the interaction between IHT and income tax on inherited pensions is complex. If this applies to your estate, professional advice is strongly recommended.

What This Means for Your Planning

The 2027 change doesn't mean pensions are no longer valuable - they remain highly tax-efficient during accumulation and drawdown, and the spousal exemption is unchanged. But the 'pensions last' strategy that many people used specifically for IHT purposes may no longer be the right approach.

Things worth considering:

• Review whether your total estate - now including unused pension funds - exceeds your available nil-rate bands.
• Update your Expression of Wish form with your pension provider, particularly if your circumstances have changed.
• Consider whether drawing your pension down earlier (if you are in a lower tax bracket to do so) makes sense for your overall plan.
• Explore whether gifting strategies, using annual exemptions and the seven-year rule, could reduce the overall IHT position.
• Revisit any trust arrangements or will provisions that were structured around the old pension rules.

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The RetirePlan Finance Planner

The Finance Planner's 25-year projection models your retirement income and estate position over time. While it does not model IHT liability directly, the Drawdown Sequencing tool can help you think through the order in which you draw on different assets - which is now an important part of the picture. Use it alongside the guidance in this chapter to inform the questions you take to a professional adviser.

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8. IHT at a Glance - KeyFigures and Rules

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9. When to Seek Professional Advice

IHT is one of the more complex areas of UK personal finance, and the rules interact with pension taxation, trust law, property ownership structures, and lifetime gifts in ways that are easy to get wrong. This guide covers the essential framework - but estate planning decisions based on it alone could be costly.

You should consider taking regulated advice if:

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• Your total estate - including property, savings, investments and (from April 2027) unused pension funds - is likely to exceed your available nil-rate bands.
• You have a substantial pension pot and want to understand how the 2027 changes affect your estate plan.
• You have made, or are considering making, significant gifts and want to understand the IHT implications.
• You have business interests or agricultural assets that may qualify for relief.
• You have a defined benefit pension or multiple pension arrangements from different employers.
• Your estate involves assets held in trust, overseas property, or non-UK domicile considerations.
• You want to ensure your will, pension nominations and estate plan work together efficiently.

A regulated financial adviser or solicitor who specialises in estate planning can model different scenarios for you, taking into account your specific circumstances. The RetirePlan Adviser Search can help you find a regulated adviser in your area.

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