Inheritance tax explained Inheritance tax: thresholds, rates and who pays

Inheritance tax (IHT) is a tax on money or possessions you leave behind when you die, and on some gifts you make during your lifetime. 

However, a certain amount can be passed on tax-free; this tax-free allowance is officially called the 'nil-rate band'.  

What is inheritance tax? Video guide


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Video transcript

If your estate is worth more than 325,000 pounds when you die, your heirs will have to pay inheritance tax on everything over that amount. But they'll pay nothing, if your estate totals less than that. Your estate includes your property, savings, and any other assets you pass on after debts and funeral expenses have been paid.

And the tax rate is 40%. But if your estate is entirely inherited by your spouse or civil partner, they don't have to pay any inheritance tax. Anything after the 325,000 pound figure is called the nil-rate band. And the figure is attached to the estate of the person who dies, rather than to the people who inherit.

The nil-rate band can be passed on to a surviving spouse or civil partner. And they can add it to their own nil-rate band. Meaning that when they die, they can leave an estate worth 650,000 pounds that's free of inheritance tax. So what happens if you give away money and property while you're still alive? You can make gifts of up to 3000 pounds in any tax year, without worrying about inheritance tax.

And you can give far more tax free, as long as you live for seven years after you've made the gift. But if you die within seven years of making it, HMRC will treat it as part of your estate. So how much tax will be due? Inheritance tax is due only on anything above the 325,000 pound threshold.

It's normally 40%, but it's cut to 36%, if you give away a tenth of your estate to charity. Lastly, there's something else that's worth knowing. From 2017, there's going to be an extra allowance covering the value of your main home, starting at 100,000 pounds but rising to 175,000 pounds per person by 2020.

Combined with a normal nil-rate band, it means an individual will be able to leave 500,000 pounds, and a couple up to a million, without their estate being subject to inheritance tax at all. To find more about inheritance tax see [SOUND]

Everyone in the 2016-17 tax year has a tax-free inheritance tax allowance of £325,000. The allowance has remained the same since 2010-11, and will stay frozen until at least 2019. 

You can also give away a certain amount of your money during your lifetime, tax-free and without it counting towards your estate. Such gifts are covered later (see inheritance tax planning and tax-free gifts).

The Which? Money Helpline offers independent guidance on all types of tax issues, including those involving inheritance tax. If you're not a Which? member, and you'd like to get unlimited access to our Money Helpline experts, you can try Which? Money for two months for £1.

Inheritance tax thresholds and rates

If you are single and die during the tax year 2016-2017 with an estate worth more than £325,000 (including money, property and investments, but after deducting debts and expenses such as funeral costs), 40% tax will become due on anything above £325,000.

For example, if you leave behind an estate worth £500,000 the tax bill will be £70,000 (40% on £175,000 – the difference between £500,000 and £325,000).

However, if you are married or in a civil partnership, you may be able to leave more than this before paying tax.

Mother and daughter on the patio

Inheritance tax is no longer just a tax for the wealthy

Inheritance tax rule changes 

In the 2015 Summer Budget, the Chancellor, George Osborne announced a new transferable main residence allowance, which will gradually increase from £100,000 in April 2017 to £175,000 per person by 2020/21. 

This is in addition to the main nil-rate band. It will effectively raise the IHT-free allowance to £500,000 per person. 

Where married couples jointly own a family home and want to leave this to their children, the total IHT exemption will be £1m.          

Inheritance tax rules for married couples and civil partners

Married couples and civil partners are allowed to pass their possessions and assets to each other tax-free and the surviving partner is allowed to use both tax-free allowances (providing one wasn’t used at the first death). 

At the extreme, this effectively doubles the amount the surviving partner can leave behind tax-free without the need for special tax planning.

However, some people whose partner died before 21 March 1972 will be caught by a loophole which means they don't get a 'double allowance'. 

Making a gift

As well as on your estate at death, inheritance tax may also be payable on gifts you make during your lifetime, especially if you die within seven years of making the gift.

Gifts fall into four basic categories:

Who pays the inheritance tax bill?

Inheritance tax that becomes due on money or possessions passed on when you die is usually paid from your estate. Basically your estate is made up of everything you own, minus debts such as your mortgage and expenses such as funeral expenses.

However, if the tax is due on gifts you made during the last seven years before your death, the people who received the gifts must pay the tax due.

If they cannot or will not pay, the amount due then comes out of your estate.

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Last updated:

April 2016

Updated by:

Ian Robinson

Which? Limited (registered in England and Wales number 00677665) is an Introducer Appointed Representative of Which? Financial Services Limited (registered in England and Wales number 07239342). Which? Financial Services Limited is authorised and regulated by the Financial Conduct Authority (FRN 527029). Which? Mortgage Advisers and Which? Money Compare are trading names of Which? Financial Services Limited. Registered office: 2 Marylebone Road, London NW1 4DF.