UK Inheritance Tax Explained: Who Pays, How Much, and How to Avoid the 40% Death Tax

Inheritance tax (IHT) is a tax on the estate (property, money, possessions) of someone who has died. It charges 40% on estates over £325,000 (the nil-rate band), or £500,000 if you leave your home to children (adding the residence nil-rate band of £175,000). Married couples can combine allowances for £1 million tax-free (£325k + £175k × 2). But only 4% of estates pay IHT (most are below the threshold), and it raised £7.5 billion in 2023–24 (1.3% of total tax revenue), paid by 27,000 estates with an average bill of £275,000. IHT is controversial — critics call it a "death tax" that punishes savers and is easily avoided by the wealthy (business relief, trusts, offshore assets). Here is everything you need to know about inheritance tax — who pays, how much, and how to legally reduce your bill to zero.

How Inheritance Tax Works

What is taxed?

Inheritance tax is charged on your estate when you die. Your estate includes:

• Property (house, land)
• Savings (bank accounts, ISAs, Premium Bonds)
• Investments (shares, bonds, funds)
• Possessions (cars, jewellery, art, furniture)
• Life insurance (if not in trust)

Your estate does not include:

• Pensions (usually pass tax-free to beneficiaries)
• Jointly owned property (passes to surviving owner)
• Gifts made 7+ years before death (see below)

The nil-rate band (£325,000)

The nil-rate band is the amount you can leave tax-free. It is currently £325,000 (frozen since 2009).

If your estate is below £325,000, you pay no IHT.

If your estate is above £325,000, you pay 40% on the amount over £325,000.

Example:

• Estate: £500,000
• Nil-rate band: £325,000
• Taxable: £175,000
• IHT: £70,000 (40% of £175,000)

The residence nil-rate band (£175,000)

The residence nil-rate band (RNRB) is an additional allowance if you leave your home to your children or grandchildren. It is currently £175,000 (introduced 2017, fully phased in 2020).

This increases the tax-free threshold to £500,000 (£325,000 + £175,000).

Conditions:

• You must own a home (or have owned one and downsized/sold it)
• You must leave it to your children or grandchildren (not siblings, nieces, nephews, friends)
• If your estate is over £2 million, the RNRB is reduced by £1 for every £2 over (so it disappears at £2.35 million)

Example:

• Estate: £600,000 (including £400,000 home)
• Nil-rate band: £325,000
• Residence nil-rate band: £175,000
• Total tax-free: £500,000
• Taxable: £100,000
• IHT: £40,000 (40% of £100,000)

Married couples and civil partners

Married couples and civil partners can combine their allowances, giving a total tax-free threshold of £1 million (£325,000 + £175,000 × 2).

How it works:

• When the first spouse dies, their estate passes to the surviving spouse tax-free (no IHT on transfers between spouses)
• The surviving spouse inherits the deceased spouse's unused nil-rate band and residence nil-rate band
• When the surviving spouse dies, their estate can use both allowances

Example:

• First spouse dies, leaves everything to surviving spouse (no IHT, unused allowances transferred)
• Surviving spouse dies with estate of £900,000
• Combined nil-rate band: £650,000 (£325,000 × 2)
• Combined residence nil-rate band: £350,000 (£175,000 × 2)
• Total tax-free: £1 million
• Taxable: £0
• IHT: £0

Who Pays Inheritance Tax?

Only 4% of estates pay IHT (27,000 out of 600,000 deaths per year). Most estates are below the threshold.

Who pays?

IHT is paid by estates worth over £325,000 (or £500,000 with residence nil-rate band, or £1 million for couples).

Typical estates that pay IHT:

• London and South East homeowners (house prices are high, so estates exceed £500,000)
• Wealthy individuals (savings, investments, second homes)
• Business owners (though business assets often get relief, see below)

Who does not pay?:

• Most people (96% of estates are below the threshold)
• Married couples (can combine allowances for £1 million tax-free)
• People who give away their wealth (gifts made 7+ years before death are tax-free)

How Much Does Inheritance Tax Raise?

IHT raised £7.5 billion in 2023–24 (1.3% of total UK tax revenue).

This is paid by 27,000 estates (4% of deaths), with an average bill of £275,000.

Why so little?

IHT raises relatively little because:

• Most estates are below the threshold (96% of estates pay nothing)
• Married couples can combine allowances (£1 million tax-free)
• Business and farm relief (see below) allows wealthy people to avoid IHT
• Trusts and offshore assets allow the very wealthy to avoid IHT

How to Avoid Inheritance Tax

1. Leave everything to your spouse

Transfers between spouses are tax-free (no IHT). This defers IHT until the second spouse dies, and allows you to combine allowances (£1 million tax-free).

2. Give money away (7-year rule)

Gifts made 7+ years before death are tax-free. If you die within 7 years, the gift is taxed (though taper relief reduces the rate after 3 years).

Taper relief:

• 0–3 years: 40% IHT
• 3–4 years: 32% IHT
• 4–5 years: 24% IHT
• 5–6 years: 16% IHT
• 6–7 years: 8% IHT
• 7+ years: 0% IHT

Example:

• You give £100,000 to your children
• You die 5 years later
• The gift is taxed at 24% (taper relief)
• IHT: £24,000

3. Use annual gift exemptions

You can give away £3,000 per year tax-free (no 7-year rule). You can also carry forward one unused year (so £6,000 in one year).

Other exemptions:

• £250 per person (small gifts, unlimited recipients)
• £5,000 to a child getting married
• £2,500 to a grandchild getting married
• £1,000 to anyone else getting married
• Regular gifts from income (e.g., paying a grandchild's school fees) are tax-free if they do not reduce your standard of living

4. Give to charity

Gifts to charity are tax-free (no IHT). If you leave 10%+ of your estate to charity, the IHT rate on the rest is reduced from 40% to 36%.

Example:

• Estate: £500,000
• Nil-rate band: £325,000
• Taxable: £175,000
• Give 10% to charity: £50,000
• Taxable (after charity): £125,000
• IHT at 36%: £45,000 (instead of £70,000 at 40%)

5. Business relief (100% tax-free)

Business assets get 100% relief (no IHT) if you own them for 2+ years before death. This includes:

• Shares in an unlisted company (e.g., family business)
• Shares in AIM-listed companies (Alternative Investment Market)
• Business property (e.g., factory, shop, farm)

This is a massive loophole that allows wealthy people to avoid IHT by investing in AIM shares or family businesses.

6. Agricultural relief (100% tax-free)

Farmland gets 100% relief (no IHT) if you own it for 2+ years and use it for farming. This is why wealthy people buy farmland to avoid IHT.

7. Trusts

Trusts can be used to reduce IHT, but they are complex and require professional advice. Trusts allow you to:

• Give assets away but retain some control
• Protect assets from creditors, divorce, or care home fees
• Reduce IHT by moving assets out of your estate

But trusts have their own tax rules (10-year charges, exit charges), so they are not always beneficial.

8. Life insurance in trust

Life insurance payouts are usually part of your estate (and taxed at 40%). But if you put the policy in trust, the payout goes directly to your beneficiaries (tax-free).

This is a simple way to cover your IHT bill without reducing your estate.

The Debate

Arguments for IHT

• Taxes wealth, not work — IHT taxes unearned wealth (inheritance), which is fairer than taxing earned income
• Reduces inequality — IHT prevents the concentration of wealth in a few families (dynasties)
• Raises revenue — £7.5 billion per year funds public services

Arguments against IHT

• Double taxation — the money was already taxed when earned (income tax, capital gains tax)
• Punishes savers — people who save and invest are penalised, while people who spend everything pay nothing
• Easily avoided by the wealthy — business relief, trusts, and offshore assets allow the rich to avoid IHT, so it falls on the middle class (£500k–£1m estates)
• Emotionally painful — paying tax on a deceased parent's estate feels cruel
• Discourages saving — people spend their wealth to avoid IHT, rather than passing it on

Should IHT be abolished?

Some argue IHT should be abolished because it raises little revenue (£7.5 billion, 1.3% of total tax), is easily avoided by the wealthy, and is unpopular.

Others argue it should be strengthened — close loopholes (business relief, trusts), lower the threshold, or increase the rate.

The Conservative Party has flirted with abolishing IHT, but it is politically difficult (it would benefit the wealthy and cost £7.5 billion per year).

The Bottom Line

Inheritance tax (IHT) charges 40% on estates over £325,000 (nil-rate band), or £500,000 if you leave your home to children (residence nil-rate band). Married couples can combine allowances for £1 million tax-free (£325k + £175k residence × 2), but only 4% of estates pay IHT (most are below threshold). IHT raised £7.5 billion in 2023-24 (1.3% of total tax revenue), paid by 27,000 estates, with average bill £275,000. You can avoid IHT by: gifting money 7+ years before death, using annual gift exemptions (£3,000/year), leaving to spouse (tax-free), or giving to charity (tax-free). Business assets and farmland get 100% relief (tax-free), making IHT avoidable for the wealthy but unavoidable for middle-class homeowners with £500k-£1m estates. Inheritance tax is controversial — it taxes wealth, reduces inequality, and raises revenue, but it is easily avoided by the wealthy (business relief, trusts, offshore assets) and falls on the middle class. Most people do not pay IHT (96% of estates are below the threshold), but those who do pay a lot (average £275,000). If you are likely to pay IHT, plan ahead — give money away, use exemptions, put life insurance in trust, and take professional advice. The 7-year rule is the most powerful tool — give away your wealth and survive 7 years, and it is tax-free.