Understanding the Inheritance Tax Thresholds and How to Maximize Your Allowances

Inheritance tax (IHT) is a crucial factor to consider when planning how your wealth will be passed on after your death. As of the 2024/25 tax year, the threshold for IHT in the UK is set at £325,000. If your estate exceeds this value, your beneficiaries may be liable to pay inheritance tax on the amount over this threshold. However, various rules and allowances can help reduce or eliminate this tax burden.

Here’s a breakdown of how the inheritance tax-free allowance works and what options are available to help you manage your estate.

How Does the Inheritance Tax-Free Allowance Work?

Inheritance tax is applied to the total value of your estate, which includes assets such as property, savings, investments, and possessions, minus any liabilities like debts or funeral expenses. All UK estates are entitled to the basic inheritance tax allowance, also known as the nil-rate band, which is £325,000.

If your estate is worth more than this amount, IHT may be applied to the portion exceeding the £325,000 threshold. The standard IHT rate is 40%, so if your estate is valued at £800,000, you would pay 40% tax on the £475,000 above the nil-rate band, which amounts to £190,000. This means your beneficiaries would receive £610,000, after tax, from the original £800,000 estate.

What Is the Residence Nil-Rate Band (RNRB)?

In addition to the basic £325,000 nil-rate band, there is a residence nil-rate band (RNRB), which was introduced in April 2017. This offers an additional £175,000 tax-free allowance, but it only applies if you leave your residential property to direct descendants such as children, grandchildren, or stepchildren.

To qualify for the RNRB, you must meet the following conditions:

• You must have owned or partly owned the property in which you lived, on or after 8 July 2015.
• The property must be passed to your direct descendants (children, grandchildren, etc.).

Some important things to note about the RNRB:

• It applies to one property per estate only.
• The value of the property determines how much of the RNRB can be used. If your property is worth £150,000, only £150,000 of the allowance can be used.
• If you’re married or in a civil partnership, any unused RNRB can be transferred to your surviving partner, potentially allowing them to benefit from the full £175,000 allowance.

For estates valued over £2 million, the RNRB is subject to taper relief. For every £2 that the estate exceeds £2 million, the available RNRB reduces by £1. For example, if an estate is worth £2.1 million, the RNRB would be reduced by £50,000 to £125,000. If the estate exceeds £2.35 million, the RNRB is no longer available at all.

How Much Wealth Can I Pass on Without Paying Inheritance Tax?

In the 2022 Autumn Statement, the former Chancellor Jeremy Hunt confirmed that both the standard nil-rate band (£325,000) and the RNRB (£175,000) will remain frozen until April 2028. This means that, as property and investments rise in value, more estates could end up falling into the inheritance tax bracket.

If you can fully use both the standard nil-rate band and the residence nil-rate band, your total tax-free inheritance allowance could be £500,000. For married couples or civil partners, this could be doubled to £1 million if both parties utilize their allowances. By passing your entire estate to your spouse, you can ensure that your unused allowances are transferred to them, which could significantly reduce the tax burden on their estate.

The Bottom Line

The inheritance tax-free threshold starts at £325,000 for individuals, but if you own a property that qualifies, your threshold could rise to £500,000. Married couples or civil partners can transfer these allowances to each other, potentially increasing the inheritance tax-free amount to £1 million. This gives you an opportunity to pass on more wealth to your loved ones, free from inheritance tax.

However, for those with substantial estates, such as high-net-worth individuals or investors with large portfolios, these thresholds may only apply to a small portion of the estate. In these cases, considering additional strategies such as tax-efficient investments, setting up trusts, or gifting assets during your lifetime could further reduce the inheritance tax liability and maximize the wealth passed on to beneficiaries.