UnderstandingTax

Inheritance Tax Explained

The nil-rate bands, another 60% stealth rate, and what's changed for business owners and pension savers

Inheritance Tax has a reputation for affecting everyone, but HMRC's own figures say otherwise: around 4.72% of UK deaths — fewer than 1 in 20 — actually resulted in a tax charge in the most recent year reported. It's charged on the estate itself, before anything is distributed, normally settled by the executor out of the estate's own funds rather than billed directly to whoever inherits. This page covers how much is actually owed and why; see Reducing Inheritance Tax for the reliefs and gift planning that can bring that down.

The nil-rate band and residence nil-rate band

Every estate gets a tax-free nil-rate band of £325,000. If a home is left to children, grandchildren, or other direct descendants, a second allowance, the residence nil-rate band, adds up to £175,000 on top, taking a single person's tax-free threshold to £325,000 + £175,000 = £500,000.

Worked example: the nil-rate and residence nil-rate bands

Say someone leaves an estate worth £600,000, including their home, which passes to their children.

  • Nil-rate band: £325,000
  • Residence nil-rate band (home passing to children): £175,000
  • Combined threshold: £325,000 + £175,000 = £500,000
  • Taxable estate: £600,000 − £500,000 = £100,000
  • Inheritance Tax due: £100,000 × 40% = £40,000

£560,000 reaches the family after tax.

Both thresholds have been frozen for years and are now confirmed frozen through the 2030/31 tax year. As house prices and other assets grow, more estates cross them each year without either allowance actually growing to match. This is yet another example of fiscal drag.

Passing your allowance to a spouse or civil partner

Anything left to a spouse or civil partner is exempt from Inheritance Tax entirely, and any percentage of their nil-rate band or residence nil-rate band left unused on the first death carries over to the survivor's estate. It's the unused percentage that transfers, not a cash amount, so it still works even if the first spouse's estate has grown or shrunk by the time of the second death. Used in full, this takes a couple's combined tax-free threshold to £1,000,000, before any other relief.

Worked example: passing an allowance to a spouse

Say Spouse A dies first. They leave £162,500 directly to their children, exactly half of the nil-rate band, and everything else, including the home, to Spouse B. What passes to a spouse is exempt from Inheritance Tax entirely, and since the home went to Spouse B rather than a direct descendant, none of the residence nil-rate band is used on the first death at all.

  • Nil-rate band left unused, to carry over: 50%
  • Residence nil-rate band left unused, to carry over: 100%

Spouse B dies some years later, this year, leaving their own home, worth £900,000 in total, to their children.

  • Nil-rate band: £325,000 of their own, plus 50% inherited from Spouse A (£162,500): £487,500
  • Residence nil-rate band: £175,000 of their own, plus 100% inherited from Spouse A (£175,000): £350,000
  • Combined threshold: £487,500 + £350,000 = £837,500
  • Taxable estate: £900,000 − £837,500 = £62,500
  • Inheritance Tax due: £62,500 × 40% = £25,000

£875,000 reaches the family after tax. That's well short of the full £1,000,000 ceiling mentioned above, because that figure only applies when both allowances transfer in full, and here only one of them did.

The two allowances transfer independently, and often at different percentages from each other, the way the example above shows. The full £1,000,000 figure is a ceiling, only reached when both allowances transfer in full; a more typical estate lands somewhere below it.

The residence nil-rate band taper: another 60% stealth rate

The residence nil-rate band doesn't just disappear once an estate gets large enough, it tapers away gradually. Once an estate is worth more than £2,000,000, the residence nil-rate band reduces by £1 for every £2 the estate is worth above that, until it's gone completely at £2,350,000.

Here's what that does to the marginal rate, not the overall bill, but what happens to the next pound the estate is worth. Losing 50p of allowance for every extra £1 means £1.50 becomes newly taxable at 40% for every £1 gained, an effective 60% marginal rate. It's the same headline number as the 60% Tax Trap on Income Tax, arrived at a different way.

Marginal Inheritance Tax rate by estate value. Drag the marker below, or use the slider, to see the exact rate at any point.

At an estate worth £2,100,000.00: a marginal Inheritance Tax rate of 60%.

Of the next £1,000 the estate is worth, £600.00 goes to Inheritance Tax, £400.00 reaches whoever inherits it.

Worked example: the residence nil-rate band taper

Say an estate is worth £2,100,000, £100,000 over the £2,000,000 taper threshold.

  • Residence nil-rate band lost to the taper: £50,000 (£1 for every £2 over the threshold)
  • Residence nil-rate band remaining: £125,000
  • Combined threshold: £450,000
  • Taxable estate: £1,650,000
  • Inheritance Tax due: £660,000

The marginal rate matters more than the total here: for every extra £1 this estate is worth in this band, 60% of it goes to tax, not the standard 40%. Losing 50p of residence nil-rate band for every £1 the estate gains makes an extra 50p newly taxable too, on top of the £1 itself.

The rate: 40%, or 36% if you give to charity

Once the available thresholds are used up, Inheritance Tax is charged at a flat 40% on everything above them. There are no further bands the way there are with Income Tax. Leave 10% or more of the net estate to charity and the rate on the rest drops to 36%, though whether that trade-off makes sense for a given estate depends on its specific numbers.

The 2026 changes to business and agricultural property

Business Property Relief and Agricultural Property Relief can shelter a family business or working farm from Inheritance Tax, but the rules changed significantly from 6 April 2026, and it's worth being precise about exactly how, since an outdated figure has circulated widely. The reform was first announced with a £1 million allowance; before it actually took effect, that was revised up to £2,500,000, and made transferable between spouses. If you've seen "£1 million" reported anywhere, it's the superseded figure, £2,500,000, that is actually in force.

From 6 April 2026: qualifying agricultural and business property gets 100% relief up to a combined £2,500,000 allowance, shared across both reliefs together, not £2,500,000 each. Above that, relief drops to 50%, an effective 20% Inheritance Tax rate on the excess. Like the nil-rate bands, any unused allowance transfers to a surviving spouse, so a couple can shelter up to £5,000,000 of qualifying property between them.

Worked example: Business and Agricultural Property Relief

Say someone's estate includes a family business worth £3,500,000, qualifying in full for Business Property Relief, plus £500,000 of other assets. No home passing to descendants here, to keep the example focused on the relief itself.

  • Fully relieved, within the £2,500,000 allowance: £2,500,000
  • Above the allowance: £1,000,000, relieved at 50%, leaving £500,000 taxable
  • Taxable value from the business (£500,000) plus other assets (£500,000): £1,000,000
  • Less the nil-rate band: £325,000
  • Taxable estate: £675,000
  • Inheritance Tax due: £270,000

£3,730,000 of the original £4,000,000 reaches the family, despite the business being “fully relieved” up to £2,500,000, the estate still owes six figures on the slice above it.

Shares in a company not listed on a recognised stock exchange, such as AIM, are treated differently from the rest of this relief. Rather than 100% relief up to the allowance, they get a flat 50% relief in all circumstances, on the full value, with no allowance at all. If a family business is held via AIM shares specifically, it's worth checking which set of rules actually applies.

What's changing in 2027: pensions

This one hasn't happened yet, but it's confirmed, enacted policy, not a proposal: from 6 April 2027, most unused pension funds and death benefits will be brought into the value of a person's estate for Inheritance Tax purposes. Today, most pensions sit outside the estate entirely, which is part of why they're often used as a later-life savings vehicle specifically. From that date, that stops being generally true.

Worked example: pensions inside the estate from 2027

Say someone's estate (home and savings, passing to their children) is worth £400,000, plus a separate £300,000 pension pot.

  • Before 6 April 2027: the pension sits outside the estate. £400,000 is under the £500,000 combined threshold, so Inheritance Tax due: £0
  • From 6 April 2027: the pension counts too. Estate value: £700,000, taxable estate: £200,000, Inheritance Tax due: £80,000

Same family, same non-pension assets. A bill that doesn't exist today will exist from that date, purely because of where the pension sits relative to the threshold.

There's a second layer worth understanding, and it isn't new: if the pension holder died at age 75 or older, death benefits are already subject to Income Tax at the beneficiary's own marginal rate, a rule that exists today, separate from the Inheritance Tax change above. From 2027, both can apply to the same pension. They don't simply add up on the full amount twice, though: Income Tax is only charged on whatever's left after Inheritance Tax, not the original value all over again.

Worked example: pension death benefits taxed twice

Say the same kind of £200,000 pension is inherited from someone who died at age 75 or older, old enough that Income Tax on pension death benefits already applies today, separately from the 2027 change above.

  • Inheritance Tax attributed to the pension: £200,000 × 40% = £80,000
  • Remaining after Inheritance Tax: £120,000
  • Income Tax on that remainder, at a higher-rate beneficiary's 40% marginal rate: £48,000
  • What the beneficiary actually receives: £72,000

£128,000 of the original £200,000 goes to tax between the two, a combined 64% effective rate. Income Tax only applies to what's left after Inheritance Tax, not the original amount twice over, which is why this comes out lower than some of the more alarming headline figures in circulation.

This page explains general Inheritance Tax rules and is not personalised advice; see the disclaimer. Estate planning, gifting, trusts, and business/agricultural reliefs depend heavily on individual circumstances; speak to a qualified solicitor or financial adviser before making decisions.