Inheritance Tax: The Two Bands That Decide Whether You Pay

The bands do all the work here. Whether an estate pays anything depends on how much tax-free allowance it can assemble, and the same three things use that allowance up: a house that appreciated for thirty years, a threshold frozen since 2009, and gifts made slightly too late.

The bands, and how a couple reaches a million

The nil-rate band has been £325,000 since April 2009. On top sits the residence nil-rate band of £175,000, available when a main home passes to direct descendants: children, stepchildren, adopted children and grandchildren. A house left to a brother or niece does not attract it.

Take a widower with an estate of £800,000 including a home going to his two children. His bands total £500,000, leaving £300,000 taxable at 40%, so £120,000 goes to HMRC.

Now take a married couple. Everything passing to a spouse is exempt, and whatever bands the first to die did not use transfer across. On the second death, an estate of £1.2 million with the home going to the children has £650,000 of nil-rate band plus £350,000 of residence band, a full £1 million. Only £200,000 is taxable, so the bill is £80,000. Let the first spouse's bands go unused and the estate has just £500,000 of shelter, leaving £700,000 taxable and a bill of £280,000.

The two million pound taper

The residence band is withdrawn by £1 for every £2 an estate exceeds £2 million. An estate of £2.35 million is £350,000 over, half of which is £175,000, wiping out the residence band entirely. Estates just above £2 million can therefore face a marginal rate far above 40%.

Gifts and the seven-year rule

Give something away and survive seven years and it leaves your estate completely. Die within seven years and it comes back in, using up your nil-rate band first.

Taper relief is widely misunderstood. It reduces the tax on a gift, not its value, and only bites where the gift exceeded the nil-rate band. Say £500,000 was given away four and a half years before death. The first £325,000 is covered by the band, and the remaining £175,000 is taxed at 24% instead of 40%, so £42,000 rather than £70,000.

Smaller exemptions work immediately. £3,000 a year can be given away with no seven-year wait, and an unused allowance carries forward one year. Gifts of £250 to any number of different people are exempt, as are wedding gifts of £5,000 to a child. Regular gifts genuinely made out of surplus income, documented as such, sit outside the estate from day one.

Using the inheritance tax calculator

The calculator wants the total estate, the value of the home, whether a late spouse's bands are available, who inherits the property, gifts made in the last seven years and any charitable legacies.

Value the house from recent Land Registry sold prices for the street rather than an optimistic asking price, since HMRC works from open market value at the date of death. Debts come off: a £700,000 house with a £180,000 mortgage contributes £520,000. Funeral costs are deductible too.

Life insurance counts unless the policy was written in trust, a common and expensive oversight. Joint accounts count at your share. Pensions have generally sat outside the estate for inheritance tax, though that is changing, so check current HMRC guidance rather than an old article. For what heirs will pay on income an inherited asset produces, see the UK income tax calculator guide.

Common questions

Do I pay inheritance tax on money left by my husband or wife? No. Transfers between spouses and civil partners are exempt without limit, and the survivor also inherits any unused bands to use later.

Does giving my house to my children avoid the tax? Usually not. Carry on living there rent free and it counts as a gift with reservation of benefit, so it stays in your estate. There can also be capital gains tax for the children later, and stamp duty consequences if they already own property, covered in how UK stamp duty works.

Who pays the bill, and when? The executors, from estate funds, due six months after the end of the month of death. Tax on property can be paid in ten annual instalments, but interest runs on the balance.

Does leaving money to charity reduce the rate? Yes. Leave 10% or more of the net estate to charity and the rate on the rest drops from 40% to 36%. Around the 10% mark, giving more can cost the other beneficiaries very little.