A guide to inheritance tax: FAQs and a glossary of terms

2 minutes

Confused by the rules associated with inheritance tax in the UK? Money journalist Felicity Hannah breaks it down in this simple guide.

  • The inheritance tax rules – and what’s changing?
  • What you can do to reduce what’s owed.
  • The key terms you need to know.

Inheritance tax rules - explained

You want your loved ones to inherit your estate without having a considerable bill to pay – but that means taking action now. Many people’s estates don’t attract any inheritance tax (IHT); only around 8% of all families will pay any tax at all in the 2016/17 tax year [1]. However, the number of people whose property falls under the scope of the tax has been growing over recent years.

Ben Cordiner (@BenCordiner), director and independent financial adviser (IFA) at the Financial Advice Company, explains: ‘Rising property values and stock markets, combined with the freezing of the IHT allowance at £325,000 since 2009, mean more estates than ever are paying inheritance tax.

‘It’s important to think about IHT as early as possible, as it provides you with greater time and flexibility in the options available to reduce your liability. The younger you are, the greater the chance that your plans will be effective.’


What are the rules?

So who actually pays inheritance tax and how much? In the 2017/18 tax year, anyone can leave an estate worth up to £325,000 without any tax being owed by the beneficiaries – that’s known as the ‘nil-rate band’. Above that, the estate is subject to a tax of 40%.

And that threshold has been frozen until 2020/21 – and possibly beyond – so that’s going to keep dragging more estates into the tax bracket. Couples can inherit each other’s allowance as long as they’re married or in a civil partnership, meaning they can leave a home or estate worth up to £650,000 without any tax becoming due. That’s not a loophole that exists for unmarried couples.

‘If a couple are not married, or in a civil partnership, assets are potentially liable to inheritance tax,’ explains Bev Stoves, director and IFA at Investment Sense (@ukinvestment). ‘Getting married to save IHT isn’t the most romantic reason to walk down the aisle, but it certainly can be effective!’


New rules for family homes

From April 2017, a new rule comes into play: a new tax-free band will be introduced, allowing children, step-children and grandchildren to inherit the person’s main residence.

Now, it gets slightly complicated – it’s being phased in over the next three-and-a-bit years. In April 2017 there will be a £100,000 main residence allowance, which, when added to the £325,000 IHT threshold, would mean that potentially an estate worth £425,000 will be exempt from the tax.

It will then rise by £25,000 every year up to £175,000 at the start of the 2020/21 financial year, meaning a total tax-free allowance of £500,000. This means a couple who are married or in a civil partnership could hand on an estate to their beneficiaries worth up to £1m without troubling the taxman to take a penny.

That’s good news, but there is a cut-off. Homes worth £2m or more will lose £1 of the main residence allowance for every £2 of additional value. If your home is worth £2.35m or more then your beneficiaries won’t get the extra allowance and you’ll be subject to the £325,000 threshold for singletons or £650,000 for a couple.

As of December 2016, the average UK house price is £219,544, so most people will fall well below this bracket [2].


How to reduce liability 

‘The starting point for most people is to write wills as tax effectively as possible; for example, make sure the family home is left to the children,’ says Peter Adcock (@peterjadcock), director and IFA at Adcock Financial. ‘Next, if you can afford it, give money away each year to use the annual IHT exemption of £3,000 per person.

‘For younger people, with large estates, using a life insurance policy, which pays out a lump sum equal to the tax due, is often a cost-effective way to address the problem,’ he adds.

Ben Cordiner goes into further detail about the gifting loophole: ‘Parents and grandparents are often keen to provide financial assistance to children and grandchildren. Helping younger generations with the cost of education and getting onto the housing ladder can be compatible with reducing IHT bills. However, giving money away is not without its potential pitfalls.

Plan financially and develop a spending or gifting programme to help reduce IHT, make sure financial objectives are met and that you won’t run out of money in your lifetime.’

Tax efficiency is all well and good, but it’s still important to have enough to enjoy your retirement.

Alternatively, you could consider putting some money into a trust. By setting up a trust for your chosen beneficiary, and meeting the conditions of the trust correctly, you can leave a sum of money that won’t be taken into account when your inheritance tax is worked out [3].



Struggling with some of the inheritance language? Here’s our quick guide:

  • Assets: Anything you own with value
  • Beneficiary: A person or organisation who benefits from your estate
  • Estate: What you leave at your death once any debts are cleared
  • IHT: This is an abbreviation of ‘InHeritance Tax’ (because ‘IT’ was already taken!)
  • Intestate: Dying without a will
  • Nil rate band: The amount of an estate that is exempt from IHT
  • Potentially exempt transfer: A gift you make that will be exempt from IHT, just as long as the giver lives for seven years after making it – you can give gifts worth up to £3000 each year without being taxed

Next steps

This guide is a bit of a whistle-stop tour of inheritance tax. It’s a complicated area of financial planning and everyone’s circumstances are very different.