How does inheritance tax work?

What is inheritance tax?¹

When someone dies, everything they owned, like their house, money and belongings, makes up what's called their estate. Inheritance tax (often shortened to IHT) is a tax that might be charged on the value of that estate before it’s passed on to family or friends. 

Not every estate has to pay this tax. Whether inheritance tax is due depends on how much the estate is worth and who inherits it. There are rules, limits and exceptions that can make a big difference. 

How much is the inheritance tax threshold?

Everyone gets a tax-free allowance called the nil-rate band. This is the amount your estate can be worth before any inheritance tax is charged. As of October 2025, the nil-rate band is £325,000. 

If your estate is worth less than £325,000, there’s no inheritance tax to pay. If it’s worth more, only the part above that amount is taxed. The standard rate is 40%. 

For example, if your estate is worth £500,000: 

• The first £325,000 is tax-free 

• The remaining £175,000 is taxed at 40% 

• That means the tax bill would be £70,000 

For the most up to date information about inheritance tax thresholds, please check the HMRC website. 

Can the threshold be higher?³

Yes, sometimes you can get a bigger tax-free allowance. 

If you leave your house to your children or grandchildren when you die, you might get something extra called the residence nil-rate band. This can give you up to £175,000 more tax-free. So altogether, you might not have to pay tax on up to £500,000. 

If you're married or in a civil partnership, you can pass on your unused tax-free allowance to your partner if you die, and vice versa. This can raise the amount the other person can leave without paying inheritance tax up to £650,000. But HMRC must be told within two years after the second person dies. Couples who aren’t married or in a civil partnership can’t use this rule. 

Who pays inheritance tax and when?

Inheritance tax is typically paid out of the estate before anything is given to family or other beneficiaries.  

The person in charge of the will, called the executor, usually sorts this out. Beneficiaries of your estate usually don’t have to pay tax, unless they earn an income from what you leave them.  

If you give gifts, those receiving them may need to pay tax on anything given within the seven years before your death. We’ll look at this seven-year rule shortly. 

Inheritance tax must normally be paid within six months of the end of the month when the person died. If it’s late, HMRC will charge interest on the amount that’s due. 

When the estate includes property or land, the tax can be paid in yearly instalments for up to 10 years. This makes things easier if the home isn’t sold straight away. 

Inheritance tax on gifts

Some gifts are automatically free from inheritance tax, such as: 

• Gifts between spouses or civil partners 

• Gifts to charities or political parties 

• Gifts up to £3,000 each tax year (this is called your annual allowance) 

• Small gifts of up to £250 per person each tax year 

• Wedding or civil partnership gifts: up to £5,000 for a child, £2,500 for a grandchild, or £1,000 for anyone else

The 7-year rule on gifts 

There’s also what’s known as the seven-year rule.  

If you give away money or property worth more than your allowance, and live for seven years after giving it, the gift is usually tax free. But if you die within seven years, tax may still be due.  

The closer the gift to your death, the higher the tax: 

• Within 3 years: 40% 

• 3–4 years: 32% 

• 4–5 years: 24% 

• 5–6 years: 16% 

• 6–7 years: 8% 

This sliding scale is called “taper relief.” 

Gifts you still benefit from

If you give something away but continue to use it, it’s called a “gift with reservation.” These gifts still count as part of your estate for tax purposes. 

For example, if you transfer your house to a family member but keep living there without paying rent, it’s still treated as yours. The same applies if you give away a painting but keep it on display, or hand over a caravan but continue using it. 

Life insurance and inheritance tax

How does life insurance affect inheritance tax?

Life insurance can play an important role in inheritance tax planning. A policy pays out a lump sum when you die, which can help your family cover debts like a mortgage, funeral costs or ongoing living expenses. But whether it’s taxed depends on how the policy is arranged. 

If the policy isn’t written in trust 

The payout is added to your estate, which can: 

• Push your estate above the tax-free threshold 

• Increase the inheritance tax bill 

• Delay payment until probate (the legal process of sorting out your estate) is complete 

If the policy is written in trust 

The payout goes directly to your chosen beneficiary. This means it: 

• Doesn’t count as part of your estate 

• Usually isn’t subject to inheritance tax 

• Can be paid quickly, without waiting for probate 

Read some of the reasons you might want life insurance 

How to put your life insurance into a trust

A trust is a legal arrangement that lets you pass money or property to others, while keeping some control over how it’s managed. 

To put life insurance into trust, you fill out a trust form with your insurer. You name your beneficiaries (the people who’ll receive the money) and appoint trustees to look after the policy. Trusts can be especially useful if you want to protect funds for children or someone who might struggle to manage their money. 

There are different types of trusts, each with their own rules and possible costs. It’s wise to get legal or financial advice to make sure you pick the right one for your situation. 

Read MoneyHelper guidance on setting up a trust 

Is death in service taxable?

A death in service benefit is a lump sum paid by an employer if you die while working for them. If it’s paid directly to a named beneficiary, it usually doesn’t count towards your estate. But if it’s paid into your estate, inheritance tax may apply. 

Many employers set up these benefits in trust to avoid tax and delays. It’s worth checking how your own scheme is arranged. 

Other steps to think about 

Inheritance tax and grandchildren 

Passing wealth directly to grandchildren can also help reduce inheritance tax. Some allowances apply specifically here: 

• Wedding gifts of up to £2,500 are tax free 

• You can leave up to £500,000 tax free if you pass your home to children or grandchildren 

Giving directly to grandchildren can also help skip a generation of tax. Instead of passing assets to your children first (where inheritance tax may be charged twice in future), you can move them directly to grandchildren, making use of allowances and the seven-year rule. 

Inheritance tax and business or agricultural assets 

Some business and agricultural assets may qualify for special reliefs. These can reduce their value for inheritance tax purposes and, in some cases, remove the tax altogether. 

For example, you might be able to claim Business Relief if you own shares in a private company, or Agricultural Relief if you own farmland. These rules can be complex, so it’s usually best to get expert advice if you own assets like these. 

Leaving part of your estate to charity 

Leaving money to charity can reduce the inheritance tax bill on your estate. 

Gifts to charities are usually tax free. On top of that, if you leave at least 10% of your estate to charity, the rate of inheritance tax on the rest of your estate may fall from 40% to 36%¹. 

This can be a meaningful way to support causes you care about, while also helping your loved ones pay less in tax. 

Read more about charity giving and tax on GOV.UK