Inheritance tax thresholds Explained: What counts and how to calculate

Worked Examples

Single Person, No Home Left to Children:
If your estate is worth £400,000 and you do not leave your home to children or grandchildren, only the nil-rate band applies. IHT would be due on £75,000 (£400,000 minus £325,000).

Married Couple, Home Left to Children:
If a couple’s combined estate is worth £950,000 and the main home is left to children, both nil-rate bands and both residence nil-rate bands may be available. Up to £1 million could be passed on tax-free, so no IHT would be due.

Large Estate Over £2 Million:
If the estate is worth £2.3 million, the residence nil-rate band is reduced by £1 for every £2 over £2 million. In this case, the residence nil-rate band would be lost entirely, and only the nil-rate band(s) would apply.

Inheritance Tax (IHT) is a tax on the estate of someone who has died, and the amount your loved ones may have to pay depends heavily on the thresholds and allowances in place. Many people find the rules confusing, especially when it comes to what’s included in the threshold, how the residence nil-rate band works, and how to add up the allowances. Understanding these details is essential if you want to minimise the tax burden on your family.

Current IHT Thresholds and Rates

Every individual benefits from a nil-rate band, which means the first £325,000 of your estate is not subject to IHT. This threshold has remained unchanged for several years. If you leave your main home to your children or grandchildren, you may also benefit from the residence nil-rate band, which can add up to £175,000 to your tax-free allowance. However, this additional allowance is reduced for estates worth more than £2 million, and not every estate will qualify for the full amount.

Anything above these thresholds is usually taxed at 40%. If you leave at least 10% of your net estate to charity, the rate on the remainder may be reduced to 36%. The residence nil-rate band is only available in certain circumstances and is subject to tapering for larger estates, so it’s important to check whether your estate qualifies.

How to Calculate Your Allowances

To work out how much of your estate is tax-free, you need to add together your nil-rate band (£325,000) and, if eligible, your residence nil-rate band (up to £175,000). For married couples and civil partners, any unused nil-rate band and residence nil-rate band can be transferred to the surviving spouse or partner. This means a couple could potentially pass on up to £1 million tax-free, provided both allowances are fully available and the main home is left to direct descendants.

If the first spouse used some of their allowance (for example, by leaving part of their estate to someone other than their spouse), only the unused portion can be transferred. It’s important to keep records of how the first estate was distributed, as this will affect the calculation for the second death.

What Counts Towards the Threshold?

The value of your estate includes:

• Property (including your main home and any other real estate)

• Savings and investments

• Personal possessions (such as jewellery, cars, and art)

• Certain gifts made in the seven years before death

Some assets, such as pensions and certain business or agricultural property, may qualify for reliefs or be excluded from the calculation, depending on the circumstances.

Common Ambiguities and Pitfalls

• Not realising that the residence nil-rate band only applies if the home is left to direct descendants.

• Overlooking the tapering of the residence nil-rate band for estates over £2 million.

• Failing to keep records of gifts, which can make it difficult for executors to claim exemptions.

• Assuming all jointly owned assets are automatically exempt or that all gifts are outside the estate after seven years, without considering the “gift with reservation” rules.

Why It Matters

Getting the calculation right can make a significant difference to what your family inherits. If your estate is close to or above the thresholds, it’s important to keep up to date with the latest rules and consider the impact of any changes in your circumstances, such as marriage, divorce, or the birth of children or grandchildren.

Feel less anxious and more confident:
Caira is your new bestie! 👱🏼‍♀️🌸 Get answers and drafts in seconds for public, family, probate, conveyancing, criminal, employment, medical negligence, commercial and public law. All backed by 10,000 legal documents for England and Wales.

Upload documents, screenshots and photos for even more relevant responses. Free 14 days trial in 1min – no credit card required, afterwards just £15/month on our website. https://www.unwildered.co.uk

Disclaimer: This blog post provides general information for educational purposes only. It is not legal advice. Outcomes can vary based on your personal circumstances and the evidence available.