Inheritance Tax UK: Thresholds, Exemptions, the 7-Year Rule and 2026 Changes

The Nil-Rate Band and Residence Nil-Rate Band

Inheritance Tax (IHT) is governed in the UK by the Inheritance Tax Act 1984 and is administered by HMRC. It is charged at a rate of 40% on the chargeable value of an estate above the nil-rate band (NRB) at the date of death. The NRB has been frozen at £325,000 since the 2009-10 tax year and is currently frozen at this level until April 2030 under HM Treasury policy. The OBR projects that this freeze, combined with rising house prices, will bring an increasing proportion of UK estates into IHT liability over the freeze period.

HMRC IHT statistics for 2023-24 show that approximately 4.4% of UK deaths generated an IHT liability, producing £7.5 billion in receipts. The OBR projects this will rise to over £10 billion per year by 2027-28 if the freeze continues and house prices remain at current levels. Rising house prices are the primary mechanism through which the frozen NRB draws more estates into IHT - an estate worth £350,000 in 2009 when the NRB was set would be worth approximately £530,000 at average house price growth rates by 2026, with £205,000 above the NRB attracting a £82,000 IHT charge.

The Residence Nil-Rate Band was introduced by the Finance (No. 2) Act 2015 and provides an additional NRB of up to £175,000 for estates that include a qualifying residence passed to direct descendants. Direct descendants include children, grandchildren, step-children, and adopted children. The RNRB applies to the lower of the property value or £175,000 per individual. For couples, both the NRB and the RNRB are transferable between spouses and civil partners on the first death - a surviving spouse can inherit both NRBs unused, giving an effective combined threshold of £1,000,000 for married couples or civil partners passing a qualifying residence to direct descendants.

The RNRB is tapered for larger estates. For estates with a net value above £2,000,000, the RNRB is reduced by £1 for every £2 of estate value above this threshold. An estate worth £2,350,000 loses the full £175,000 RNRB and benefits only from the standard £325,000 NRB.

The 7-Year Rule and Potentially Exempt Transfers

Gifts made during a lifetime are classified as Potentially Exempt Transfers (PETs) under the Inheritance Tax Act 1984. A PET becomes fully exempt from IHT if the donor survives for seven years after making the gift. If the donor dies within seven years of the gift, the PET is brought back into the estate and uses the NRB or attracts IHT at a tapering rate.

Taper relief reduces the IHT charge on gifts made between three and seven years before death. Gifts made three to four years before death face an 80% charge (32% effective rate on the excess above the NRB). Gifts made four to five years before death face 60% charge (24% effective rate). Five to six years: 40% charge (16% effective rate). Six to seven years: 20% charge (8% effective rate). Taper relief applies to the IHT charge, not to the value of the gift itself, and only on the amount exceeding the NRB - gifts within the NRB face no IHT regardless of the 7-year position.

Annual Exemptions and Small Gift Allowances

Several exemptions allow gifts to be made free of IHT without the 7-year rule applying. The annual gift exemption of £3,000 per donor per tax year can be given away free of IHT. If unused in the previous tax year, the previous year's allowance can be carried forward, allowing up to £6,000 in a single year. The small gifts exemption allows gifts of up to £250 to any number of individuals in a tax year free of IHT. The normal expenditure out of income exemption allows regular gifts made from surplus income - not capital - that do not reduce the donor's standard of living to be exempt from IHT.

The wedding or civil partnership gift exemption allows parents to give up to £5,000, grandparents up to £2,500, and others up to £1,000 free of IHT on the occasion of a marriage or civil partnership. Gifts to registered charities, political parties, national institutions, and maintenance payments for dependent relatives or former spouses are exempt without limit.

Pension Pots and IHT: The 2027 Change

Until April 2027, defined contribution pension pots sit outside the estate for IHT purposes. A deceased individual's unused pension fund passes to nominated beneficiaries without being subject to IHT, making the pension one of the most tax-efficient vehicles for intergenerational wealth transfer. This position changes materially from April 2027 under changes announced in the Autumn Budget 2024, when unused pension pots will be included in the estate for IHT purposes.

The 2027 change significantly affects the financial planning calculus for higher-wealth individuals who have accumulated large pension pots specifically for IHT efficiency. The change does not affect pension income drawn in the normal way - it affects only the undrawn remainder of pension pots at death. The precise implementation rules, including interaction with the NRB and RNRB, are subject to ongoing consultation but the policy direction is clear.

Business and Agricultural Property Relief

Business Property Relief (BPR) and Agricultural Property Relief (APR) provide full or partial IHT relief for qualifying business and agricultural assets. BPR at 100% applies to shares in unquoted trading companies, sole trader businesses, and partnership interests. APR at 100% applies to agricultural land and property occupied for agricultural purposes.

The Autumn Budget 2024 curtailed these reliefs for high-value assets. From April 2026, BPR and APR at 100% apply only to the first £1 million of qualifying assets. Above £1 million, relief is reduced to 50%, resulting in an effective IHT rate of 20% on the excess. This change has significant implications for family farm and business succession planning and generated substantial public debate from agricultural and business communities in 2024 and 2025.

Frequently Asked Questions

What is the inheritance tax threshold in the UK?

The nil-rate band is £325,000 in 2026-27, frozen until April 2030. The Residence Nil-Rate Band adds £175,000 for qualifying estates passing a main residence to direct descendants. A married couple or civil partners can combine both nil-rate bands and both residence nil-rate bands on the second death, creating an effective threshold of up to £1,000,000 for qualifying estates.

How does the 7-year rule work for gifts?

Gifts made more than seven years before death are fully exempt from IHT. Gifts made within seven years are Potentially Exempt Transfers - they use the nil-rate band or face a tapering IHT charge if the donor dies within seven years. Taper relief reduces the charge on gifts made between three and seven years before death, from 80% of the full charge at three to four years down to 20% at six to seven years.

Are pension pots subject to inheritance tax?

Currently no - pension pots outside the estate pass to nominated beneficiaries free of IHT. From April 2027, undrawn pension pots will be included in the estate for IHT purposes under changes announced in the Autumn Budget 2024. This significantly affects estate planning for those with large pension accumulations and changes the strategic calculus around pension drawdown timing.

What is the annual gift exemption?

£3,000 per donor per tax year. Unused allowance from the previous tax year can be carried forward, allowing up to £6,000 in a single year. Gifts of up to £250 to any number of individuals are separately exempt. Regular gifts from surplus income that do not reduce the donor's standard of living are also fully exempt under the normal expenditure from income exemption.