Inheritance Tax Threshold UK Explained: Allowances and Rules

In short

Most estates in the UK pay no Inheritance Tax at all, because the inheritance tax threshold is higher than people expect.

Every person has a £325,000 nil-rate band, and tax is charged only on the value above it, at 40 per cent. A further £175,000 residence nil-rate band can apply when a main home passes to children or grandchildren. Married couples and civil partners can pass unused allowances to each other, which is how a couple can reach up to £1 million tax-free.

The practical starting point is simple: estimate what the estate is worth, add up the allowances that apply, and compare the two. For most households, no tax is due.

£325,000Nil-rate band, per person

£175,000Extra, if the home goes to children

£1 millionPotential total for a couple

Couple reviewing their estate and inheritance tax position with a financial adviser

What counts as your estate?

Before the inheritance tax threshold means anything, you need a rough value for what you would be leaving behind. Your estate is everything you own, minus everything you owe.

What you own includes your home, savings and investments including ISAs, your car, valuables such as jewellery, and the payout from life insurance policies unless they are written in trust.

What you owe includes the outstanding mortgage, loans, credit card balances and any other debts. These come off the total.

A simple example: a £400,000 house plus £50,000 in savings, less a £100,000 mortgage, gives an estate of £350,000.

Life insurance is the one people most often get wrong. A policy paid into the estate counts towards the total; the same policy written in trust usually does not. It is worth checking which yours is.

The £325,000 nil-rate band

The most important figure in the inheritance tax threshold is the tax-free allowance everyone has: £325,000. This is the nil-rate band, and anything up to it passes on without tax.

Tax applies only to the amount above it, and then at 40 per cent. This is where the most common misunderstanding sits. If an estate is worth a pound more than the allowance, the whole estate is not suddenly taxed. Only the excess is.

An estate of £425,000 has £100,000 above the allowance. The tax is 40 per cent of that £100,000, so £40,000, not 40 per cent of the whole estate.

The £175,000 residence allowance

Property values push a lot of estates past £325,000 on their own, which is why there is a second allowance specifically for the family home.

The residence nil-rate band is worth up to £175,000, and it applies when a main home is left to direct descendants: children, including adopted and stepchildren, or grandchildren. Added to the main allowance, that takes an individual to £500,000 tax-free.

The condition matters. If the home goes to a sibling, a niece or a friend, this allowance does not apply. It is specifically for passing the home down a generation.

One catch on larger estates. The residence allowance is reduced for estates worth more than £2 million, by £1 for every £2 above that figure. On a large enough estate it disappears entirely, which is why the £2 million mark matters more than people expect.

Family discussing how inheritance tax allowances transfer between spouses

How couples reach £1 million

For married couples and civil partners the rules are considerably more generous, for two reasons.

First, anything left to a surviving spouse or civil partner is normally free of Inheritance Tax regardless of the amount, where both are UK domiciled. There is no ceiling on the spouse exemption in that situation, though different rules apply where the surviving spouse is not UK domiciled.

Second, allowances transfer. When the first partner dies leaving everything to the other, their own allowances usually go unused, and those unused allowances are not lost. The survivor's estate can claim them later.

That means the surviving partner effectively has two sets: their own £500,000 plus their partner's unused £500,000, giving a potential £1 million that can pass to children with no Inheritance Tax at all.

A worked example

Jane is a widow. Her husband David died some years ago and left everything to her, so his estate passed tax-free and none of his allowances were used.

Jane dies leaving an estate of £850,000, including the family home, which goes to her children.

Jane's own allowances: £325,000 nil-rate band plus £175,000 residence allowance, so £500,000
David's unused allowances, transferred: a further £500,000
Total tax-free threshold for her estate: £1 million

£850,000 estate against a £1 million threshold. No Inheritance Tax is due.

That example is deliberately ordinary. A widow with a family home and some savings is a common situation, and it is the situation in which people most often assume there will be a bill when there is not.

The 7-year rule and gifting

Giving money away during your lifetime reduces the estate that is eventually assessed. Some gifts are exempt straight away.

Annual exemption: £3,000 each tax year. If you do not use it, you can carry it forward one year
Small gifts: £250 per person, to as many people as you like, as long as you have not used another exemption on the same person that year
Wedding gifts: £5,000 from a parent, £2,500 from a grandparent or great-grandparent, £1,000 from anyone else

Larger gifts work differently. They are potentially exempt transfers, and a seven-year clock starts from the date of the gift. Live seven years and the gift falls out of the estate entirely. Die within seven years and it counts back against the allowances.

Taper relief is the part most often misunderstood. It does not reduce the value of the gift, and it only applies where the gifts themselves exceed the nil-rate band. Where it does apply, it reduces the tax due on gifts made between three and seven years before death, on a sliding scale.

Keep a record. Note what you gave, to whom, and when. Executors piecing this together years later without records is where the difficulty usually arises.

Your three-step check

Estimate the estate. What you own, minus what you owe
Add up the allowances. £325,000, plus £175,000 if a main home is going to children or grandchildren, and any allowances transferable from a late spouse
Compare the two. If the estate is below the allowances, there is no Inheritance Tax to pay

Most families find they are comfortably inside, and for them that is the end of it. If the estate is close to or above the threshold, that is the point at which advice is worth having, and the point at which options like gifting, trusts or life cover written in trust become worth discussing.

Where the threshold may be heading

The inheritance tax threshold has included a £325,000 nil-rate band since 2009, and it is currently frozen. Because allowances are frozen while property prices are not, the number of estates falling into Inheritance Tax has been rising, and is expected to keep rising.

There are also changes coming to how unused pension funds are treated on death. If pensions form a significant part of what you plan to leave behind, this is worth a specific conversation rather than a general guide.

Rules and thresholds change. The figures above are current at the time of writing; check the position on GOV.UK or with an adviser before acting on them.

Independent financial adviser in Halifax explaining inheritance tax planning options

Common questions

Every person has a nil-rate band of £325,000, and Inheritance Tax is charged at 40 per cent only on the value above it. A further residence nil-rate band of up to £175,000 can apply when a main home is left to children or grandchildren, taking an individual to £500,000.

No. Tax applies only to the amount above the allowances, not to the whole estate. An estate of £425,000 has £100,000 above the £325,000 nil-rate band, so the tax is 40 per cent of that £100,000, which is £40,000, rather than 40 per cent of everything.

Potentially £1 million. Anything left to a surviving spouse or civil partner is normally free of Inheritance Tax, and unused allowances transfer to the survivor. Their estate can then use their own £500,000 plus their partner's unused £500,000.

Often not. The residence nil-rate band of up to £175,000 applies where a main home passes to direct descendants, which includes children, adopted and stepchildren, and grandchildren. Combined with the nil-rate band that covers an estate of up to £500,000 per person.

No. It only applies where a main home passes to direct descendants, so leaving it to a sibling, a niece or a friend does not qualify. It is also reduced for estates worth more than £2 million, by £1 for every £2 above that figure.

Seven years. Larger gifts are potentially exempt transfers, and if you live seven years after making one it falls out of your estate entirely. Die within seven years and it counts back against your allowances, though taper relief may reduce the tax due.

Where does your estate stand?

Every Step Financial Services is based at Croft Myl on West Parade in Halifax. If you want to know where your own estate sits, or you have worked out that it is over the threshold and want to know the options, the first conversation is free and there is no obligation.

Arrange a free chat

Or call 01422 652300 and speak to Joanne.

Related guides

Inheritance tax gift rules explained, how lifetime gifts, exemptions and the 7-year rule work in more detail
Gifting money to children: UK tax rules, a practical guide to helping family during your lifetime
Inheritance tax planning in the UK, the main approaches families use to reduce a liability
Putting your house in trust, what it does, what it does not do, and the drawbacks
Equity release and inheritance, how releasing money from a home affects what you leave behind

This guide is general information only. It is not personal financial advice, tax advice or legal advice, and it does not take account of your circumstances, your estate or your objectives. Inheritance Tax rules are complex and subject to change, and tax treatment depends on individual circumstances. You should not rely on this guide when making decisions. For advice specific to your situation, speak to a suitably qualified adviser.

Every Step Financial Services is an Appointed Representative of New Leaf Distribution Ltd, which is authorised and regulated by the Financial Conduct Authority. Firm reference number 460421.

Where Does Your Estate Stand?

Tell us a little about your situation. You do not need to have made a decision, a question is enough. Or call 01422 652300 and speak to Joanne.