Leaving money to family and friends at death: how inheritance tax is applied across different assets

Labour’s 2024 Budget contained proposals to bring more assets into the clutches of inheritance tax (IHT) for the first time as well as an extended freeze of the tax-free allowances and thresholds. Currently around one in 20 estates pay IHT, but this is expected to narrow to one in 10 by the end of this parliament.

What is in my estate?

Your ‘estate’ includes your money, property, savings, investments and possessions. Most pensions currently sit outside of your estate, but this is due to change from April 2027.

It’s worth mentioning that assets can be left tax-free to spouses and civil partners. This is not the case for unmarried partners or other family members though, even if you have lived together for many years.

Everyone can pass on up to £325,000 tax-free thanks to the nil rate band. An additional £175,000 ‘residence’ nil rate band is available where homeowners leave the main family property to their direct descendants.*

Unused nil rate bands (including the residence nil rate band) can also be passed to a surviving spouse or civil partner. This, together with the fact transfers between spouses and civil partners are IHT exempt, is why you’ll often read that most married couples can pass on an estate worth up to £1 million on second death to their beneficiaries without IHT applying.

*The residence nil rate band starts to be tapered for estate’s worth over £2 million.

What is the rate of IHT?

IHT is usually charged at a rate of 40% on the value of an estate above the available nil rate band(s) and exemptions.

Some large gifts you made in your lifetime might benefit from taper relief when you die, which could reduce the rate of IHT charged. Other reliefs for business and agricultural assets mean some types of assets and investments can also be passed on free of IHT, or at a reduced tax rate.

If you give more than 10% of your estate minus any debts to charity, IHT can be charged at a lower rate of 36%.

Who pays IHT?

Your personal representatives (executors) are responsible for calculating and paying any IHT due from funds in your estate. This should be done within six months of death to avoid extra interest. Your beneficiaries do not usually have to pay IHT themselves, but it can reduce the value of what they eventually receive.

Under the proposals for pensions, the scheme administrator will be responsible for deducting any tax due before funds are paid to your beneficiaries.

How does IHT apply to different investment accounts?

Listed shares and investment funds

The value of your investments will form part of your estate, but you can name who you’d like them to go to in your will. Anything left to your spouse of civil partner will be exempt from IHT. Your beneficiary(s) should keep note of the value of the investments as at the date of your death, as this will be needed to work out any capital gains on any future sales they make.

If you bought investments with another person (e.g. in a joint Dealing account), then your share of the account will automatically transfer to the surviving owner. They will be deemed to inherit the additional amount(s) as at the value of the date of your death. This will affect the overall cost for capital gains when they come to sell.

Qualifying AIM shares are currently exempt from IHT if held for at least 2 years. But the value of this tax benefit will be halved from 6 April 2026, meaning IHT of 20% for qualifying investments.

ISAs

You can name who you’d like to inherit the value of your ISA in your will. If you leave what's in your ISA to your spouse or civil partner, there will be no IHT to pay, but it may be due if you leave the underlying investments to other beneficiaries.

Your spouse can also inherit an additional ISA allowance when you die, on top of their own £20,000 annual allowance. It means you can pass on not just the total wealth in your ISA(s) to them, but its tax-free status too. This additional allowance is available, even where you leave some of the ISA assets to someone else. Learn more about additional subscriptions.

Pensions

Pensions are currently outside of your estate for IHT purposes. However, the government has announced plans to include unused pensions and certain pension death benefits in the value of estates where a pension holder dies on or after 6 April 2027. Other existing IHT exemptions will also apply to pensions including the ‘spousal exemption’.

Under current rules, income tax is paid by your pension beneficiaries (including spouses and civil partners) on the money they withdraw if you die aged 75 or older. No income tax is payable if you die before reaching the age of 75.

If the changes are introduced as expected, some beneficiaries will have to pay income tax (at their own marginal rate) on an inherited pension from someone over age 75, after any inheritance tax has already been deducted.

At the time of writing, we don’t know the final rules for how IHT on unused pensions will work. You can still pass your pension to your beneficiaries without incurring inheritance tax until April 2027.