Tax Guide: How to Reduce Inheritance Tax Legally — Allowances, Trusts and Planning Strategies for 2025/26

Inheritance Tax is charged at 40% on the value of an estate above the nil rate band (NRB). The NRB has been frozen at £325,000 since 2009 (see GOV.UK inheritance tax guidance for the official thresholds) and will remain there until at least 5 April 2030 — over two decades without an increase.

However, there is a second allowance: the Residence Nil Rate Band (RNRB) of £175,000, available when a qualifying home is passed to direct descendants (children, grandchildren, stepchildren). This brings the combined threshold to £500,000 per person.

For married couples and civil partners, any unused NRB and RNRB can be transferred to the surviving partner's estate. This means a couple can potentially pass on up to £1,000,000 before any IHT is due.

The RNRB tapers for estates worth more than £2 million — it is reduced by £1 for every £2 above this limit, disappearing entirely at £2.35 million (individual) or £2.7 million (couple using both RNRBs). For high-value estates, this tapering can be a significant planning challenge.

Our IHT rates and thresholds guide covers the full rate structure. A reduced IHT rate of 36% (instead of 40%) applies if you leave at least 10% of your net estate to charity in your will.

For more on this topic, see our guide to Wills, Probate, and Protecting Your Family's Future in 2025/26.

The simplest way to reduce your estate is to give assets away during your lifetime. Several exemptions allow tax-free gifting:

• Annual exemption: You can give away up to £3,000 per tax year free of IHT. If unused, the previous year's allowance can be carried forward for one year, allowing a one-off gift of £6,000.
• Small gifts exemption: You can give up to £250 to any number of individuals per tax year (but not to someone who has already received your annual exemption).
• Wedding or civil partnership gifts: Parents can give up to £5,000, grandparents up to £2,500, and anyone else up to £1,000 per wedding.
• Gifts to charities, political parties, and national institutions: These are completely exempt from IHT, with no limit.

Perhaps the most powerful exemption is gifts out of surplus income. If you can demonstrate that regular gifts come from income (not capital) and do not affect your standard of living, these are immediately exempt from IHT with no upper limit. This requires keeping records — ideally a schedule showing income, expenditure, and the surplus used for gifting.

For larger gifts that exceed these exemptions, the seven-year rule applies: if you survive seven years after making the gift, it falls completely outside your estate. If you die within seven years, taper relief reduces the tax owed on a sliding scale — from 40% in years 0–3 to 8% in years 6–7.

Pensions are one of the most tax-efficient IHT planning tools available. Defined contribution pension pots — SIPPs, workplace pensions, and personal pensions — currently sit outside your estate for IHT purposes. This means your pension pot can be passed to your beneficiaries free of IHT — see our guide to pension death benefits for the full rules, regardless of its size.

However, there is a critical change on the horizon. From 6 April 2027, unused pension funds will be brought into the scope of IHT. This will be a significant shift in estate planning, and individuals with large pension pots may need to reconsider their drawdown strategies.

Until that change takes effect, the strategy is straightforward: if you have other income sources (ISAs, savings, rental income), spend those first and leave your pension untouched for as long as possible. Every pound left in a pension is currently a pound outside IHT.

If you die before age 75, your pension beneficiaries can draw the funds tax-free. If you die after 75, beneficiaries pay income tax at their marginal rate on withdrawals, but there is no IHT charge (under current rules until April 2027).

The pension annual allowance of £60,000 (or 100% of earnings if lower) limits how much you can contribute each year. Carry forward rules allow unused allowance from the previous three tax years to be used, potentially allowing contributions of up to £180,000 in a single year if you have sufficient unused allowance.

For larger estates, more sophisticated planning tools are available:

Trusts can be used to remove assets from your estate while retaining some control over how they are distributed. Discretionary trusts, bare trusts, and interest-in-possession trusts each have different IHT implications. Setting up a trust during your lifetime is a chargeable lifetime transfer — if the value exceeds the NRB, an immediate 20% IHT charge applies (with the balance potentially charged at death if within seven years). Professional advice is essential for trust planning.

Business Relief allows business assets to be passed on with reduced or zero IHT:

• 100% relief: Unlisted shares, unincorporated businesses, interest in a partnership
• 50% relief: Shares controlling more than 50% of a listed company, land/buildings/machinery used in a qualifying business

The assets must have been owned for at least two years (per HMRC Business Relief rules). Business Relief has historically been one of the most generous IHT reliefs, but note that from 6 April 2026, relief on AIM-listed shares will be reduced to 50% (previously 100%), and Business Relief and Agricultural Relief will be capped at a combined £1 million of assets qualifying for 100% relief, with the rate above that dropping to 50%.

Agricultural Relief works similarly for farming land and property, with the same 100%/50% structure depending on the type of agricultural asset. The two-year ownership requirement and the new April 2026 cap also apply.

Life insurance written in trust is another common strategy. A whole-of-life policy written into trust provides a tax-free lump sum to pay the IHT bill, ensuring your beneficiaries receive the full estate without having to sell property or investments to cover the tax.

IHT planning is full of traps for the unwary. Here are the most common mistakes:

• Assuming your estate is too small: With average UK house prices above £285,000 and the NRB frozen at £325,000, many families with a modest home and some savings are now within the IHT net.
• Not making a will: Dying intestate (without a will) means your estate is distributed according to default legal rules, which may not align with your wishes and cannot take advantage of IHT-efficient structures.
• Gifting the family home but continuing to live in it: This is a 'gift with reservation of benefit' and does not remove the property from your estate. To work, you must pay market rent or the gift must genuinely transfer full ownership.
• Not keeping records of gifts: Regular gifts from surplus income are only exempt if you can prove the pattern. Keep a spreadsheet of all gifts, including amounts, dates, recipients, and your income/expenditure at the time.
• Leaving it too late: The seven-year rule means gifts need time to become fully exempt. Starting at 50 or 55 gives you decades of effective gifting; starting at 80 may be too late for larger transfers.

Practical steps you can take today:

1. Value your estate — add up property, savings, investments, pensions, life insurance payouts, and personal possessions
2. Write or update your will — ensure it uses both NRB and RNRB efficiently
3. Start using annual exemptions (see our tax year-end checklist for a complete list of actions) — even £3,000 per year compounds over decades
4. Consider gifts from surplus income — set up a regular pattern and document everything
5. Review your pension drawdown strategy — draw from non-pension sources first while pensions remain IHT-exempt
6. Take professional advice for estates above £500,000 — the cost of an IHT-specialist solicitor or financial planner typically pays for itself many times over

This article is for informational purposes only and does not constitute regulated financial advice. Inheritance Tax planning can be complex — consult a qualified financial adviser or solicitor before making decisions.