A comprehensive guide to inheritance tax

What is the inheritance tax limit 2024/25?

Under current rules, heirs could be subject to a tax bill of up to 40% on an estate, which includes savings, property and any additional assets, after deducting any debts and funeral costs. However, inheritance tax (IHT) can be legally reduced or avoided in a number of ways (such as via gifting and similar estate planning strategies), and will only be paid on estates worth above a certain amount.

The tax-free allowance for 2024/25 – known as the nil-rate band – stands at £325,000. This means only the value of an estate above this threshold will be taxed at 40%, and if it’s worth less than this, there’ll be no tax to pay whatsoever.

The nil rate band increases to £500,000 if a home is being passed onto a child or grandchild, provided the total estate is worth less than £2m. This extra £175,000 is known as the residence nil-rate band or property transfer allowance.

Not only that, but any assets transferred to a spouse or civil partner are entirely exempt, and couples can also pass on any unused allowance to their spouse to boost the tax-free threshold for future beneficiaries.

This means that, provided the first spouse to die didn’t gift a large amount away beforehand, couples can pass on up to £650,000 to their beneficiaries tax-free. This rises to £1m if the estate includes property, thanks to the additional property transfer allowance (£325,000 x 2, plus the additional £175,000 x 2). Find out more about inheritance tax on property, and other allowances that you can combine with your spouse to reduce your tax bill.

It can be possible to reduce an IHT charge in other ways too, such as by leaving some of the estate to charity. For example, if at least 10% of an estate is left to charity, the IHT charge may be reduced to 36%. And, if everything above the £325,000 nil-rate band is left to charity or an amateur sports club, no tax will be due.

How much can you inherit before paying inheritance tax?

As per the rules above, you can potentially inherit up to £1m before paying inheritance tax – if you’re inheriting your parents’ estate, for example – depending on your family circumstances. There are exceptions, however, most notably if you received any inheritance money as gifts in the seven years before the deceased passed away, in which case you’ll have to pay tax on it (though only if the deceased breached their nil rate band), or if you generate an income from the money received, in which case usual income tax rules apply.

The rules can be complex and often depend on your relationship with the deceased. As such, you may want to consult a professional adviser so you know exactly what your tax liabilities are, and how you can potentially mitigate them if necessary.

Who pays any inheritance tax due?

Beneficiaries rarely pay IHT directly. Any tax due is usually discounted from the value of the estate and is taken care of by the executors (unless the estate can’t or won’t cover the full amount, in which case the beneficiaries are liable).

Do you need to declare inheritance money?

No. Any tax due will normally be taken out of the deceased’s estate, and the executor will usually take care of it. This means you won’t need to declare inheritance money to HMRC – an inheritance isn’t classed as income, and therefore isn’t taxable.

Bear in mind though that you’ll need to declare any interest or dividends that you later earn from it, and you may also need to notify the Department for Work and Pensions (DWP) if you’re in receipt of any benefits.

What happens when you inherit money?

When you inherit money, you’ll first of all need to make sure that the necessary debts, funeral expenses and IHT have been paid out of the estate.

You won’t inherit the money as soon as the person dies, however; there’s a process known as probate to go through, which can take up to a year or longer if things are particularly complex. Typically speaking, you can expect to wait at least six months, even in straightforward cases.

Once you’ve received the money you’re free to spend it as you see fit, though it’s a good idea to consult a financial adviser, particularly if you receive a significant sum, to ensure you’re able to make the most of it and that you’re mitigating any tax liabilities that may become apparent.

What is the average inheritance?

The average (median) inheritance received is around £11,000, according to the most recent figures from the Office for National Statistics (ONS), but this may be well below the windfall likely to be received by future beneficiaries.

Indeed, a report from the Institute for Fiscal Studies found that, thanks to rising wealth and fewer siblings, the median inheritance for those born in the 1960s is expected to be £66,000, rising to £107,000 for those born in the 1970s and £136,000 for those born in the 1980s.

And what about average tax bills? As the figures above suggest, the vast majority of estates don’t pay any inheritance tax whatsoever, with Government figures showing that just 3.73% of UK deaths in the 2020/21 tax year resulted in an IHT charge.

Yet those who do pay typically have significant estates, which results in a significant tax bill. Indeed, in that same tax year, the average IHT bill stood at £214,000.

What is the best thing to do with inheritance money?

Deciding how to spend an inheritance can be a very personal decision, but there are a few things you may want to focus on.

The first of these things is debt. Using inheritance money to clear any personal debt you may have can be a very wise move, such as paying off maxed-out credit cards or even mortgage balances (see below). It may not be the most exciting way to spend an inheritance, but knowing you don’t have any lingering debt to worry about can be invaluable.

You might like to consider who else could benefit from your new-found windfall too, particularly if you’ve got a very large sum. Many people like to help younger family members onto the housing ladder, for example, or gift some to charity; this may also require professional input so you’re not breaching any gifting rules or tax brackets, so again, it’s always worth speaking to an adviser.

After your other potential obligations are taken care of, it all comes down to making your money work as hard as possible, but deciding how to do that – and where to put it – isn’t always easy.

Where should I put my inheritance money?

This largely depends on your circumstances and what you intend to do with the money, but at the outset, it’s a good idea to keep the sum in an accessible savings account while you decide what to do next.

Easy access savings accounts should therefore be your first port of call, but keep a lookout for access and investment restrictions, as some only allow a certain number of withdrawals and others have relatively low maximum investment limits, which may not be suitable for those with a large windfall.

Once you’ve decided what to do with the money, you can look to move it elsewhere. If you want to keep it in cash but at a higher rate you may want to consider fixed rate bonds or ISAs, or if you’ve got a higher risk appetite, stocks & shares ISAs – or similar investments – may be worth considering.

This always assumes you’re not using the money elsewhere, such as to invest in property, which could be another way to make it work harder.

Wherever you put your inheritance, make sure to bear in mind depositor protection rules, which are temporarily enhanced in the six months following a major life event (such as receiving an inheritance) and means up to £1m will be protected under the Financial Services Compensation Scheme (FSCS). Just remember to divide the money between different accounts once the six months have expired to make sure you’re suitably covered.

Should I use an inheritance to pay off my mortgage?

It’s always sensible to use inheritance money to pay off any debts, and paying off the mortgage could be top of the list of priorities. Just make sure to account for any exit fees, and if you’re on a fixed rate deal, remember that you may not be able to pay off the full balance without additional charges being applied. Always ensure it’ll be financially worthwhile, and in some cases it may be worth waiting until the fixed rate period has come to an end before paying it off. Always seek suitable advice to decide on the best course of action.

However, if you’re on a variable rate mortgage it should be far easier to pay off the balance; make sure to speak to your mortgage provider to see how you can go about it.

If you only receive enough inheritance to repay part of the mortgage, the same rules apply; check how much you can repay each year if you’re on a fixed rate, and speak to your provider if you’re on a variable rate deal. Paying down some of the mortgage may give you the opportunity to remortgage to a lower rate as you’ll be on a lower loan-to-value, so can be a great use of inheritance money.

Will I lose my benefits if I inherit money?

Potentially, depending on the benefits you’re currently in receipt of and the amount of inheritance coming your way. If you’re receiving means-tested benefits (such as income-based jobseeker’s allowance, income support or Universal Credit), any income and savings you have will affect the amount you’re entitled to – if you suddenly get a windfall in the form of inheritance, this will count as savings, and your entitlements will change accordingly.

Once your savings hit the £6,000 threshold, your benefits will be impacted (the exception to this is pension credit, where you can have up to £10,000 in savings before your entitlement is affected). This means that, if you inherit more than this amount, it’s worth spending time thinking about what you’re going to do with it. Seeking advice is key; Citizens Advice could be a great place to start.

However, benefits that aren’t means-tested (such as the disability living allowance) won’t be affected by receiving an inheritance.

How do you prove inheritance money?

You may need to prove where the large sum of money in your bank account came from – such as if you’re using it to purchase a property, in which case the solicitor will require proof of funds for conveyancing to proceed – but this shouldn’t be too onerous a task.

To prove inheritance money you’ll need a copy of the letter from the executors of the estate that sets out how much you’re receiving as a beneficiary, together with your bank statement that shows the funds came from the executor’s/solicitor’s bank account. Keep all relevant paperwork, too.

Can creditors come after my inheritance?

If you’re in serious debt and are going through the debt management process, there’s the chance you’ll have to use your inheritance to settle your creditors’ demands, particularly if you’re already in some form of insolvency (such as an IVA or bankruptcy). However, this is an incredibly complex area and seeking advice is crucial; Citizens Advice can be helpful here.

A way to avoid this is if the deceased left the inheritance in a trust, in which case the assets will be shielded from creditors, but this would need to have been arranged before the event. We’ll cover more about inheritance trusts below.

Is inheritance money protected in divorce?

This depends on your situation, but usually, inherited money will be counted as “non-matrimonial assets” and therefore won’t automatically be included in the calculation of assets to be divided in the divorce. It may be excluded completely if both parties agree, though if the matrimonial assets won’t be sufficient to cover the financial needs of both individuals, then non-matrimonial assets may be included – which is where it could get difficult.

It can often depend on how the money was used. If it went into a joint account and was used to benefit the whole family, for example, it may be viewed as joint property and will be divided accordingly. It can also depend on when the inheritance was received (if it was before the marriage, for example), if there was a pre-nuptial agreement or for how long the marriage lasted. However, such things are always decided upon on a case-by-case basis, so it’s vital to get the necessary legal advice in this situation.

How does an inheritance trust work?

An inheritance trust is a way for someone to more effectively manage their estate, giving them an element of control in how the assets are passed on and used. They’re often used as a way to reduce inheritance tax, though it will still need to be paid and it can still be expensive.

The creator of the trust would have placed certain assets in the trust and will stipulate how it should be run. Trustees will be nominated to manage the trust when the creator passes away – they’ll become legal owners of the trust at that point – and beneficiaries will be nominated in the usual way. Assets held in trust don’t form part of the estate and therefore won’t be taken into account in inheritance tax calculations – provided they were placed in trust more than seven years before the individual died – but tax would still have been paid (see below).

Do beneficiaries pay tax on inheritance from a trust?

If the estate being passed on exceeds the deceased’s IHT allowance, then yes, tax will need to be paid on inheritance from a trust – but the rules are slightly different. The deceased would have already paid 20% inheritance tax on all assets when they were originally put into the trust, as well as a 6% tax charge (less the IHT allowance) on each 10-year anniversary. When the trust is closed or the beneficiaries otherwise remove the assets, another tax charge is applied of up to 6%, depending on when the most recent 10-year valuation took place.

However, these rules can vary depending on the type of trust that was initially set up; it’s important to speak to a professional for advice.

What happens when you inherit money from a trust?

This can depend on the type of trust it is, but typically speaking, it should simply be a case of asking the trustees to pay you the money you’re entitled to. Alternatively, if there are several beneficiaries and everyone agrees, the trust could be wound up and the money distributed according to the will.