How much inheritance tax will I need to pay?

Did you know that currently in the UK, only around 4% of estates are reported to be subject to an inheritance tax bill? Despite that, it’s only natural for many of us to want to plan for the future, especially when it comes to ensuring our loved ones are well-provided for to the best of our ability once we’re no longer around to support them. Understanding how inheritance is calculated is the first step to finding out whether there’ll be any inheritance tax to pay. Our team of tax experts have created this easy-to-follow guide to explain how inheritance tax works to find out if there will be any inheritance tax payable.

How much is inheritance tax charged at?

Unlike some other taxes in the UK, such as income tax or corporation tax where the rate increases dependent on how much is earned, inheritance tax is charged at a standard flat rate of 40% on all estates that exceed the inheritance tax thresholds no matter how much by. This is yet another reason that makes inheritance tax particularly unpopular as those who are just over the threshold are subject to the same rate as the wealthiest.

What are the inheritance tax thresholds for the current tax year 2024/25?

There are two inheritance tax allowance thresholds. The first is the nil rate band (NRB) and entitles all estates up to the value of £325,000 to be exempt from inheritance tax. The second threshold acts as an extension to the NRB and is known as the residence nil rate band (RNRB). The RNRB increases the inheritance tax threshold by a further £175,000 meaning estates with a total value of no more than £500,000 remain exempt from inheritance tax. Estates which are eligible to use the RNRB are those where the deceased chooses to pass their main residence to a direct descendant (child or grandchild, including adopted children and grandchildren).

The exception to the RNRB threshold is where the total value of an estate is worth more than £2 million. Once your estate goes over this value, you begin to lose £1 from the RNRB allowance for every £2 over £2 million. In practice, this means you effectively lose the entire RNRB allowance where your estate is valued at £2.35 million or more. It is important to note that this only impacts your RNRB and your NRB remains unaffected.

Who actually has to pay inheritance tax?

Who is responsible for paying inheritance tax is one of the most frequently asked questions as well as one of the most commonly misunderstood aspects of inheritance tax. For clarity, the general rule is that inheritance tax is paid from the deceased’s own estate which means no one else is responsible for the tax due.

The one exception to this is where the deceased has gifted over the NRB within the seven years prior to their death. In this case, beneficiaries of those gifts can become liable for inheritance tax on the portion they have received. We’ll explain the 7-year gift rule in more detail below.

Are there any exemptions from inheritance tax?

In addition to those estates which fall under the NRB and RNRB (where applicable) being exempt from inheritance tax, there are some further tax exclusions to be aware of. Firstly, certain recipients of assets received from probate are exempt from inheritance tax. This includes married spouses and civil partners. In fact, in most situations, a spouse or civil partner remains exempt from inheritance tax no matter the total value they inherit, even where it exceeds the tax thresholds. What’s more, any unused portions of NRB and RNRB are automatically passed to the surviving spouse of partner to use when it comes to their own estate. This means that it is possible for an individual to pass on a maximum of £1 million tax-free to beneficiaries.

Secondly, where you elect for any UK registered charity to receive assets from your estate upon death, those assets are also exempt from inheritance tax and effectively reduces the overall value of your estate when calculating the potential tax liability. For example, if your estate as a whole is worth £550,000 but, in your will, you choose to leave £75,000 to a charity of your choice, your taxable estate becomes £475,000 (below to NRB and RNRB) thereby allowing you to avoid inheritance tax.  

Finally, small gifts to beneficiaries that are given within your lifetime can also be exempt from inheritance tax so long as they remain within specific value limits:

• Christmas and birthday gifts, or other gifts which are usually paid through your normal income.
• Gifts which fall into your annual exemption – this is £3,000 worth of gifts per tax year. This annual exemption can be carried forward to the following year, but only for one year.
• Wedding or civil ceremony gifts up to £1,000 per person that are unrelated to you, or £2,500 for a grandchild or great-grandchild, or £5,000 for a child.
• You can also make regular gifts or payments of unlimited amounts to another person so long this has is being paid for from your regular income and you can afford your usual living costs after this. Examples of these gifts include supporting another person’s living costs such as an elderly relative where you may be paying for their care home costs or a child under 18 such as for their schools fees.
• Any gifts and donations to UK registered charities.
• Small gifts of up to £250 per person, per tax year, so long as they have not received any other gifts that qualify as an exemption from this list.

How does inheritance tax get calculated?

To calculate how much inheritance tax will be due, you should follow the below steps in order:

How much is the estate worth?

To start calculating how much inheritance tax will be due you need to firstly start by determining the total value of the estate in its entirely. This includes valuing all belongings and possessions. Whilst assets such as money in current accounts, savings accounts, and pension funds are easily quantifiable, other assets such as property, jewellery, antiques and cars will need valuing.

HMRC will want any belongings worth £1,500 or more to be individually itemised on the IHT 400 form as well as professionally valued. For any items that are likely to be worth under £1,500, such as furniture and clothing, a formal valuation is not required, and you merely need to present an estimate of how much you could reasonably sell it for on the second-hand market. 

It is worth noting that executors can amend the valuation of the estate that is supplied on the IHT400 form. The timescales for making such amendments will vary depending on the asset in question. However, this does mean that should you have over-valued an item which was then sold for less, and inheritance tax was paid, you could potentially submit an amendment and recover some of the overpaid tax. This does apply where you give away items for free.

Are there any outstanding debts?

Once you have established the net value of the estate, you must next clear any outstanding debt that the deceased may have had. This can include credit card bills, mortgage payments, overdrafts, or any other debt. Where any joint debt had been taken out, this is usually automatically transferred to any surviving people and will not need to be repaid from the deceased’s estate. Any individual debt, however, must be repaid in full first before inheritance tax is paid. If there are insufficient funds to clear all debts, then debts will be repaid in priority order until assets or funds have been exhausted. Once there is no estate left, all remaining debts will be written off. Debts of the deceased will never fall onto other people unless an individual has provided a personal guarantee on the loan.

Can you use any inheritance tax relief options?

Next, you should consider whether the estate includes any assets which may qualify for inheritance tax relief. For example, Agricultural Relief for Inheritance Tax allows for some agricultural property to be passed on inheritance tax-free. It applies to land or pasture that is used to grow crops or to rear animals intensively, farm buildings and some agricultural shares and securities but does not include farm equipment and machinery, derelict buildings, livestock or harvested crops. To qualify for relief, the property must be part of a working farm in the UK and owned and occupied for agricultural purposes immediately before transfer for:

• 2 years if occupied by the owner, a company controlled by them, or their spouse/civil partner
• 7 years if occupied by someone else.

Depending on which qualifying conditions are met, agricultural relief is available at 50% or 100% of the asset.

Other types of assets which qualify for inheritance tax relief include businesses. Where the deceased owned their own business, or had an interest in a business (such as investing or making a loan to a business but was not a shareholder), or had shares in an unlisted business, such assets may qualify for 100% deduction through business relief. 50% relief is available where the deceased owned shares controlling more than 50% of voting rights in a listed company; land, buildings or machinery owned by the deceased which were used in a business they were a partner in; or land, buildings or machinery used in a business and held in trust that the business had a right to benefit from. To qualify for business relief, the deceased must have owned these business assets for at least 2 years before their death.

It is not possible to claim for agricultural relief and business relief on the same assets. However, it may be possible for a farming business to utilise business relief on assets which are not applicable under agricultural relief such as for machinery. From April 2025 onwards, full agricultural relief and business relief will only be available on the first £1 million of assets. Thereafter, only 50% relief will be offered making the effective inheritance tax rate 20% on eligible assets.

Pension funds currently fall out of the scope for inheritance tax purposes (be aware that there are proposed changes to this which may take effect from April 2027). This means that you can pass on any unused pension pots to beneficiaries inheritance-tax free. However, depending on the type of pension scheme, the beneficiaries may face other taxes when receiving it such as income tax which they would be personally liable for and does not need to be paid from the estate.     

Were any gifts given 7 years prior to death?

This is where we’ll explain what is commonly referred to as “the 7 year rule”. When calculating how much inheritance tax is due, it is necessary to also account for certain gifts that may have been made within the 7 years prior to death. This excludes any exempt gifts which we covered in the section above. Gifts which should be considered are however anything of value including cash, property, or other possessions. Where qualifying gifts have been made, they will be subject to what is known as ‘taper relief’ which is calculated as follows:

• Gifts which were made less than 3 years prior to death – 40%
• Gifts made between 3 to 4 years prior to death – 32%
• Gifts made between 4 to 5 years prior to death – 24%
• Gifts made between 5 to 6 years prior to death – 16%
• Gifts made between 6 to 7 years prior to death – 8%
• Gifts made over 7 years prior to death – 0%

As we’ve mentioned above, it’s important to remember that although in most cases recipients of gifts do not pay inheritance tax because it is paid for by the estate, they may still become liable where the deceased had gifted over the NRB 7 years prior to death.

As an example, Albert who is unmarried with no children dies in February 2022 with an estate worth £300,000. In April 2016, he gifted his sister Bridget £150,000. In November 2017, he gifted his brother Christopher £250,000. In January 2019, he gifts his niece Daisy £50,000. In his will, he also leaves £20,000 to the charity Battersea Dogs and Cats Home. 

In this scenario, no inheritance tax is due on his sister’s gift because it is fully covered by the NRB. £75,000 of his brother’s gift, however, will be subject to inheritance tax at a rate of 24% because this will push Albert’s gifts within the past 7 years over the NRB. Christopher must pay £18,000 in inheritance tax. Furthermore, his niece’s gift will be fully subject to a 32% inheritance tax rate. Daisy will need to pay £16,000 in tax. The charity is exempt from paying any tax on their gift so keeps the full £20,000. This reduces Albert’s estate from £300,000 to £280,000 which will be subject to 40%. The estate’s tax liability is £112,000.

You’ll note that when it comes to calculating inheritance tax, the oldest gifts are always accounted for first and use up the NRB. You cannot choose to allocate the NRB to the estate before gifts.

Does the overall value of the estate exceed the inheritance tax thresholds?

When all of the above information has been collated, you’ll be able to establish a reasonable estimate for the total value of the estate. Deducting all the outstanding debts will reduce the value of the estate, as well as applying potential inheritance tax reliefs that may be available on certain assets. However, you may find that value gets added back into the estate once you have factored in any non-exempt gifts from within the 7 years prior to the deceased’s passing.

Where the final figure exceeds the NRB, anything over will be subject to 40% inheritance tax unless the RNRB is applicable. Don’t forget to also consider whether any unused NRB and RNRB has been passed onto a spouse or partner.

Thinking about inheritance tax planning?

If you’re looking ahead and wanting to plan for the future, we can help provide a strategic plan of action by estimating the potential value of your estate and highlight opportunities where tax relief may be available. Get in touch to arrange a consultation with one of our tax advisors.