There are few taxes more controversial than the one taken when a person dies.

Depending on who you are talking to, Inheritance Tax is either: a double-taxation on success; a cruel punishment on prudent people; a valuable tool to redistribute wealth; or badly designed because the people that should pay most of it can avoid it.

In reality, each of these statements is, at least partially, true.

Another true statement about Inheritance Tax (IHT) is that more people complain about it than actually pay it. Recent figures from HM Revenue & Customs show that in 2015/16, the latest year for which full data are available, just 4.2% of deaths were liable for IHT.

Does that mean concern about Inheritance Tax is overblown? Not necessarily - the same figures show that this proportion has been steadily rising year-on-year, and was below 3% as recently as 2011/12. It is projected to grow above 5% by the time the 2017/18 numbers are in. This increase, along with above-inflation rises in the value of estates, means that £5.2bn a year was collected by the tax at the last count.

It isn’t all bad news, though. Changes over the past ten years have given greater flexibility to reduce IHT liabilities. Here’s what you need to know.

How IHT works

When a person dies, anything they own - their “estate” – up to the value of £325,000 can be passed on with no IHT due. This is known as the “nil-rate band”. Your estate can include any money held in cash or investments, property and other possessions.

Anything over the nil-rate band can potentially face 40% tax, but there are significant exceptions that can reduce what has to be paid.

Crucially, anything that is passed to the husband, wife or civil partner of the deceased attracts no IHT at all. If other people benefit from the estate, including children, then the value of their inheritance is tested against the nil-rate band. If the value is below £325,000, there is nothing to pay.

Spouses can share unused nil-rate band

While the nil-rate band for IHT has not been raised in line with inflation, an important change was made in 2007 that increased the scope for avoiding IHT - allowing spouses and civil partners to pass their unused nil-rate band to one another on death.

If a person dies and passes their entire estate to their spouse or civil partner and no-one else, there is no IHT to pay. The change meant that the deceased’s unused nil-rate band could also be shared, taking the surviving spouse’s nil-rate band to £650,000.

If something is passed to other beneficiaries apart from a spouse, such as children, the value of this is subtracted from the nil-rate band being shared. So a husband dying and passing £100,000 of inheritance to his children, would leave £225,000 of his nil-rate band to his surviving wife, who could then add this to her nil-rate band, meaning she could pass on £550,000 without paying any tax.

Pass on a £1m home tax-free?

Families can have even more protection from IHT if an estate includes a main residence passed to direct descendants. This extra protection is being introduced in stages and is designed to help children avoid selling a family home to pay IHT.

This year (2019/20) an additional £150,000 of nil-rate band is available to individuals in this situation, and the amount will rise again in April 2020, to a total of £175,000. By that point, people will have a total nil-rate band of £500,000.

When combined with spouses’ ability to share unused nil-rate band, it will eventually be possible for parents to pass a £1m property to their children without attracting IHT.

Pension protection from IHT

A pension that is not yet in payment is not usually included in your estate so can be passed on after death without IHT applying. There are tax implications however, depending on the type of payment, the age of the person when they died, and when the pension was established.

If an individual dies before age 75, most pensions can be passed on without tax of any kind being due, but will be assessed against the deceased’s Lifetime Allowance for pensions. If death happens after age 75 the beneficiary will have to pay income tax on the money when it is withdrawn, subject to their own tax position at the time.

IHT can be a consideration when it comes to planning your retirement finances and may require specialist professional help.

For less complicated situations, the Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at or over the telephone on 0800 138 3944.

Gifts and other IHT planning

Those with significant IHT liabilities, including land assets, could benefit from more complex tax exemptions, or legal structures called trusts. Such arrangements will require the help of a financial adviser or accountant.

Other than that, it is possible to give modest sums away before you die without the money being caught by IHT. You have an annual £3,000 allowance for 2019/20 and it is possible to carry over unused allowance from one year to the next, taking the maximum allowance in that year to £6,000. You can’t however accumulate several years of allowances to use on a larger gift.

Furthermore, you can give anyone £250 without attracting IHT, and you can make as many £250 gifts to different people as you like - although not to someone who has already benefitted from your £3,000 annual allowance.

Larger sums can be given with no IHT due if sufficient time passes before the giver dies. Such gifts - called “potentially exempt transfers” – become free of IHT once seven years has passed. If the giver dies before seven years, IHT is payable. How much depends on a taper, with the tax bill falling as time passes.

There are extra exemptions from IHT for wedding gifts, gifts to charity or political parties.

Another exemption exists for money given away from “surplus income”. To qualify, gifts must be regular and maintained without diminishing the giver’s standard of living – it may be necessary to prove this in order to qualify for the exemption.

Important information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.