Your guide to making the most of available tax breaks
Understanding
Inheritance Tax
Section One
What is
Inheritance Tax?
Death duties have been with us for centuries, in the guise of Estate Duty, Capital Transfer Tax and now Inheritance Tax (IHT). Whatever their name, the purpose is always to raise revenue from people's estates.
Once considered a tax on the rich, IHT now affects more estates than ever. It may come as a shock to discover that a large proportion of your wealth, which includes all of your assets such as the family home, investments including Individual Savings Accounts (ISAs), and life assurance plans not in trust will be included in your estate when you die.
The first £325,000 of an individual's estate (referred to as the nil-rate band) is taxed at 0%, so is not liable to IHT. Subject to no other allowances being available the entire estate in excess of the nil-rate band is taxed at a flat rate of 40%, assuming you have no charitable bequests. The table opposite shows the effect this tax can have on an estate and how HM Revenue & Customs (HMRC) could easily become the single largest beneficiary.
From 6 April 2017, each person received an additional tax-free allowance to use against the value of their estate if their home or former home is passed to a direct descendant. This additional allowance is known as the Residence Nil-Rate Band (RNRB). The RNRB is currently set at £175,000* for an individual.
| Size of estate | Amount of tax payable | % of estate paid in tax |
|---|---|---|
| £325,000 | Nil | 0 |
| £500,000 | £70,000 | 14% |
| £750,000 | £170,000 | 23% |
| £1,000,000 | £270,000 | 27% |
| £1,500,000 | £470,000 | 31% |
This assumes the individual has no entitlement to the Residence Nil Rate Band (RNRB).
Be informed
For married couples and civil partners any unused portion of the nil-rate band – or RNRB – may be transferable from the first to die to the survivor.
Transfers between UK domiciled spouses or civil partners, during lifetime or on death, are exempt from IHT.
* Will be reduced for estates in excess of £2m. This will be at a withdrawal rate of £1 for every £2 over this threshold.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
Section Two
Who needs to pay?
Up to 5 April 2025, assessment for UK IHT was based on an individual's domicile status. A person's domicile is generally the country where he or she permanently resides or intends to remain in the future. It's often referred to as 'where your heart is'.
Anyone who had their permanent home in the UK (or was 'domiciled' in the UK) was subject to IHT on 'transfers of value'. This covered all their worldwide assets with the exception of excluded property. Those who were not UK domiciled were usually only subject to IHT on their UK assets and any offshore assets (such as shares in an offshore company) that derived their value from UK residential property.
There is also the concept of 'deemed domicile', which no longer applies in the context of IHT. In the case of 'deemed domicile', the person was not UK domiciled but had been resident in the UK in 15 out of the last 20 tax years. For IHT purposes only, there was a further requirement that the individual was resident in the UK for at least one of the four preceding tax years.
Excluded property
Certain assets were excluded from IHT. These included:
- Some interests under a trust.
- Assets not situated in the UK except to the extent that they derived their value from UK residential property.
However, the individuals beneficially entitled to these assets had to be domiciled outside the UK or the assets needed to be held in a trust created at a time when the person who created the trust (also known as the settlor) was not UK domiciled.
With effect from 6 April 2025 the previous domicile-based system has been replaced with a new residence-based system. This affects the scope of property subject to UK IHT for individuals and settlements.
The test for whether non-UK assets will be assessable to UK IHT is now based on whether an individual is a "long term resident" (LTR) i.e. somebody who has been resident in the UK for at least 10 out of the last 20 years immediately before the tax year in which the chargeable event (including death) arises.
An individual who is a LTR at the point of their death will be subject to UK IHT on their worldwide assets, regardless of their domicile status. In addition, if a LTR transfers non-UK assets into a discretionary trust, this will be a chargeable lifetime transfer for IHT purposes.
It should also be noted even where an individual establishes a trust at a time when they are not a LTR, if they later become a LTR and a chargeable event, such as death, occurs the trust assets (whether in the UK or overseas) will form part of the individual's estate if they are a potential beneficiary of the trust. The trust assets will also potentially be subject to periodic charges.
Transitional rules apply and your Edwards & Power adviser will be able to provide you with further information on the new legislation.
The levels and bases of taxation and reliefs from taxation can change at any time. The value of any tax relief depends on individual circumstances.
Trusts are not regulated by the Financial Conduct Authority.
Section Three
What is a
transfer of value?
A transfer of value is any disposition (or transaction) that reduces the value of a person's estate. This includes gifts, sales at less than full value, and certain trust arrangements.
Transfers of value can be categorised into three types:
Exempt transfers
Transfers that are completely free of IHT, such as gifts between spouses or civil partners.
Potentially Exempt Transfers (PETs)
Gifts that become exempt if the donor survives for seven years after making the gift.
Chargeable Lifetime Transfers (CLTs)
Transfers that may be immediately subject to IHT at the lifetime rate of 20%.
Exempt transfers: married couples & civil partners
Transfers between UK domiciled spouses or civil partners are exempt from IHT whether made during their lifetime or on death. There is no limit to the amount that can be transferred.
However, where the transferor is UK domiciled (or a Long Term Resident from 6 April 2025) and the transferee is not, the exemption is limited to a cumulative total of £325,000.
It is possible for a non-UK domiciled spouse or civil partner to elect to be treated as UK domiciled for IHT purposes. This election must be made in writing to HMRC and, once made, is irrevocable.
From 6 April 2025, a non-UK domiciled spouse or civil partner who is not a LTR can elect to be treated as a LTR for IHT purposes. This election must be made within two years of the first transfer of value to which it is to apply.
The levels and bases of taxation and reliefs from taxation can change at any time. The value of any tax relief depends on individual circumstances.
Section Four
Exempt
Transfers
Annual exemption
Each individual can give away up to £3,000 per tax year free of IHT. If the exemption is not used in one tax year, it can be carried forward to the next tax year (but no further). The current year's exemption must be used first.
Small gifts exemption
Any number of gifts of up to £250 per recipient per tax year are exempt. This exemption cannot be used in conjunction with the annual exemption for the same recipient.
Normal expenditure out of income
Regular gifts made out of income (not capital) that form part of normal expenditure and do not reduce the donor's standard of living are exempt. This can be a particularly valuable exemption for those with surplus income.
Gifts for maintenance of dependant
Gifts made for the maintenance of a dependant relative, or for the education and maintenance of a child under 18 (or still in full-time education) are exempt from IHT.
Gifts in consideration of marriage
Gifts made in consideration of marriage or civil partnership are exempt up to certain limits:
- £5,000 from each parent
- £2,500 from each grandparent or remoter ancestor
- £1,000 from any other person
Gifts to charities and other bodies
Gifts to UK charities, political parties, national heritage bodies, and certain other organisations are exempt from IHT. Additionally, where at least 10% of the net estate is left to charity, a reduced IHT rate of 36% (instead of 40%) applies to the rest of the estate.
Section Five
PETs &
CLTs
Potentially Exempt Transfers (PETs)
A PET is a gift made by an individual to another individual, a bare trust, or a trust for a disabled person. PETs are not subject to IHT at the time they are made. If the donor survives for seven years after making the gift, it becomes fully exempt from IHT.
However, if the donor dies within seven years of making the PET, it becomes a chargeable transfer and may be subject to IHT. The amount of tax payable may be reduced by taper relief if the donor survived for more than three years after making the gift.
Any PETs made in the seven years before death will use up the nil-rate band before it can be applied to the estate on death. This means that making large gifts shortly before death could result in a higher IHT bill on the remaining estate.
Chargeable Lifetime Transfers (CLTs)
A CLT is typically a gift made to a discretionary trust (or any trust that is not a bare trust or a trust for a disabled person). Unlike PETs, CLTs may be subject to an immediate IHT charge at the lifetime rate of 20%.
The lifetime rate only applies to the extent that the cumulative total of CLTs made in the previous seven years exceeds the nil-rate band (currently £325,000).
Example
If an individual makes a gift of £350,000 to a discretionary trust and has made no other CLTs in the previous seven years, the first £325,000 is covered by the nil-rate band. The remaining £25,000 is subject to IHT at 20%, giving a tax charge of £5,000.
If the donor dies within seven years, the CLT is reassessed at the death rate of 40% (subject to taper relief). Credit is given for any lifetime tax already paid.
Trusts are not regulated by the Financial Conduct Authority.
Section Six
3 need-to-knows about
Lifetime Gifts
Gifts and trusts
There are many reasons why you might want to use a trust when making a gift. These include:
- The beneficiary is too young to manage the assets themselves
- You want to retain some control over how and when the assets are distributed
- You want to protect the assets from the beneficiary's creditors or in the event of their divorce
- You want to provide for a number of beneficiaries, but don't want to decide now how the assets should be divided
Gift with Reservation of Benefit (GROB)
If you make a gift but continue to benefit from the asset, the gift may be treated as still forming part of your estate for IHT purposes. This is known as a Gift with Reservation of Benefit. For example, if you give your home to your children but continue to live in it rent-free, the property will still be included in your estate on death.
To avoid this, you must either cease to benefit from the asset or pay full market rent for its use.
Capital Gains Tax (CGT)
When you make a gift of an asset (other than cash), you are treated as having disposed of it at its market value for CGT purposes. This means that if the asset has increased in value since you acquired it, you may have a CGT liability.
There are some reliefs available, such as holdover relief for gifts to certain trusts, which allows the gain to be deferred until the trustees dispose of the asset. Your Edwards & Power adviser can help you understand the CGT implications of any proposed gifts.
Pre-Owned Asset Tax (POAT)
POAT is an income tax charge that can apply if you have disposed of an asset (or provided funds for its purchase) but continue to benefit from it. It was introduced to counter schemes designed to avoid the GROB rules.
The charge is based on the annual rental value of the asset (for land and chattels) or on an official rate of interest applied to the value of the asset (for intangible property held in a trust).
You can elect to have the asset treated as a GROB instead, which would bring it back into your estate for IHT purposes but avoid the annual income tax charge. Your Edwards & Power adviser can help you decide which option is most appropriate.
Section Seven
Are there any
Reliefs?
Business Relief
Business Relief (BR) can reduce the value of business assets that are subject to IHT. The relief is available at two rates:
- 100% relief — for a business or interest in a business, and for unquoted shares (including AIM shares)
- 50% relief — for quoted shares giving the holder control of the company, and for land, buildings, or machinery used in a business
The assets must generally have been owned for at least two years before the transfer.
Agricultural Property Relief
Agricultural Property Relief (APR) can reduce the agricultural value of agricultural property. The relief is available at 100% where the transferor had the right to vacant possession, or at 50% in other cases. The property must have been occupied for agricultural purposes for at least two years before the transfer.
Reforms from April 2026
From April 2026, the 100% rate of BR and APR will be reformed. The first £1 million of combined business and agricultural property will continue to attract 100% relief. For amounts above £1 million, relief will be reduced to 50%, meaning an effective IHT rate of 20%.
For AIM shares, the rate of BR will be reduced to 50% from April 2026, regardless of value.
Woodlands Relief
Where an estate includes growing timber, an election can be made to leave the timber out of account when valuing the estate. IHT will then be charged when the timber is eventually disposed of.
Taper Relief
Where a PET or CLT becomes chargeable because the donor dies within seven years, taper relief may reduce the amount of IHT payable. The relief reduces the tax (not the value of the gift) on a sliding scale.
Quick Succession Relief
If a person dies and their estate includes property on which IHT was paid within the previous five years, Quick Succession Relief may reduce the IHT payable on the second death.
Section Eight
What are the
other options?
Pensions
Under current legislation, most pension funds are not subject to IHT. This is because pension benefits are usually held in trust by the pension scheme and do not form part of your estate.
If you die before age 75, your pension fund can usually be paid to your beneficiaries tax-free. If you die on or after age 75, benefits paid to your beneficiaries will be taxed at their marginal rate of income tax.
Proposed new legislation
From April 2027, the Government proposes to bring unused pension funds and death benefits within the scope of IHT. Your Edwards & Power adviser will be able to provide you with further information as it becomes available.
Life assurance
Life assurance can be a useful tool in IHT planning. A life assurance policy written in trust can provide a lump sum on death that is outside your estate for IHT purposes.
There are various types of life assurance policies that can be used for IHT planning, including:
- Whole of life policies — provide cover for the whole of your life and pay out a guaranteed sum on death
- Term assurance — provides cover for a fixed period to cover PETs and CLTs during the seven-year period
- Gift inter vivos policies — designed to cover the decreasing IHT liability on a PET or CLT
The levels and bases of taxation and reliefs from taxation can change at any time. The value of any tax relief depends on individual circumstances.
Section Nine
Who pays
and when?
The Personal Representatives (executors or administrators) of the deceased are responsible for paying the IHT due on the estate. They must pay the tax before they can obtain a Grant of Probate, which is needed to access the deceased's assets.
IHT on the estate is due six months after the end of the month in which the death occurred. Interest is charged on any tax that remains unpaid after this date.
For certain assets, such as land and property, it may be possible to pay the IHT in ten equal annual instalments. However, interest will be charged on the outstanding balance.
Failed PETs and CLTs
If the donor dies within seven years of making a PET, the PET becomes chargeable and the donee is primarily liable for the IHT. If the donee cannot pay, the liability falls on the Personal Representatives.
For CLTs, any additional IHT arising on death is the responsibility of the trustees. If the trustees cannot pay, the Personal Representatives may be liable.
Key timeline
IHT is due six months after the end of the month in which the death occurred. For example, if someone dies on 15 March, the IHT is due by 30 September.
Section Ten
Make a plan &
manage your liability
Make a plan
Be realistic
Before making any plans, it's important to have a clear picture of your financial situation. This means understanding the value of your estate, your income and expenditure, and your future financial needs. Don't give away assets that you may need in the future.
Adapt where you can
Tax rules change frequently, and your personal circumstances will also change over time. It's important to review your IHT planning regularly and adapt your strategy as needed. What worked five years ago may no longer be the most effective approach.
Keep it simple
Complex arrangements can be expensive to set up and maintain, and may not always achieve the desired result. Often, the simplest solutions are the most effective. Your Edwards & Power adviser can help you find the right balance between simplicity and effectiveness.
Manage your liability
Draw up a Will
A Will is the foundation of any estate plan. Without one, your estate will be distributed according to the rules of intestacy, which may not reflect your wishes. A well-drafted Will can also help to minimise the IHT payable on your estate.
Review your Will for tax efficiency
If you already have a Will, it's worth reviewing it to ensure it's as tax-efficient as possible. For example, you may want to consider leaving a portion of your estate to charity (to benefit from the reduced 36% IHT rate) or making use of the transferable nil-rate band.
Consider combined solutions
IHT planning often involves a combination of strategies, such as making lifetime gifts, using trusts, and taking out life assurance. Your Edwards & Power adviser can help you develop a comprehensive plan that takes into account all of your circumstances and objectives.
Protect assets for your heirs
As well as minimising IHT, you may also want to consider how to protect your assets for future generations. Trusts can be a useful tool for this purpose, as they can provide protection against creditors, divorce, and other risks.
Here for you
At Edwards & Power, we believe that effective legacy planning is about more than just minimising tax. It's about ensuring that your wealth is preserved and passed on in the way that you choose, to the people you care about most.
Our experienced advisers can help you develop a comprehensive IHT strategy tailored to your individual circumstances. Whether you're just starting to think about estate planning or you need to review an existing plan, we're here to help.
Take the next step
Contact your Edwards & Power adviser to arrange a consultation and start planning for the future.
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