The £325,000 Inheritance Tax Trap: What to Do Before 5 April While the Threshold Stays Frozen

Two thresholds determine your IHT exposure. The first is the nil rate band: £325,000 per person, unchanged since 2009 and frozen until 2030. Everything above this is taxed at 40%.

The second is the residence nil rate band (RNRB): £175,000 per person, introduced in 2017 and also frozen until 2030. This applies when you leave your home to direct descendants — children, grandchildren, stepchildren.

Combined, an individual can pass on £500,000 tax-free. A married couple or civil partnership can pass on £1 million, because any unused allowance transfers to the surviving partner.

The RNRB tapers away for estates worth more than £2 million, reducing by £1 for every £2 above that threshold. An estate worth £2.35 million gets no RNRB at all. This taper catches more people than you'd expect — a London family home plus pension death benefits can easily breach £2 million.

Your annual gift exemptions reset on 6 April. Use them or lose them.

The main one: £3,000 annual exemption. You can give away £3,000 per tax year free of IHT, to one person or split across several. If you didn't use last year's exemption, you can carry it forward for one year — giving you a potential £6,000 window right now.

On top of that:

• Small gifts: £250 to any number of people (but not the same person who received your annual exemption)
• Wedding gifts: Up to £5,000 to a child, £2,500 to a grandchild, £1,000 to anyone else
• Regular gifts from income: No limit, as long as they come from surplus income and don't affect your standard of living

The regular gifts from income exemption is the most powerful and least used. If you have a pension or investment income that exceeds your living costs, systematic gifts from that surplus are immediately outside your estate. No seven-year wait. No limit. The key is demonstrating a pattern — keep records.

Gifts above the annual exemption are potentially exempt transfers (PETs). If you survive seven years after making the gift, it falls completely outside your estate. Die within seven years and it gets pulled back in.

The taper relief schedule from HMRC reduces the tax rate on gifts made between three and seven years before death:

• 0-3 years: 40% (full rate)
• 3-4 years: 32%
• 4-5 years: 24%
• 5-6 years: 16%
• 6-7 years: 8%
• 7+ years: 0%

A critical detail that catches people: taper relief only reduces the rate of tax on the gift. It doesn't create a new nil rate band. The gift still uses up your £325,000 threshold first. Taper relief only saves money if your total gifts in the seven years before death exceed £325,000.

This means for most people, the seven-year rule is binary: survive seven years and the gift is free; die within seven years and it's counted against your nil rate band at whatever rate applies. The taper is only relevant for very large gifts.

Until recently, pensions sat outside the IHT estate entirely. Die before 75 and your beneficiaries drew the pension tax-free. Die after 75 and they paid income tax on withdrawals, but no IHT.

The Autumn Budget 2024 changed this. From April 2027, unused pension funds will be included in the estate for IHT purposes. For many families, this is the single biggest change to inheritance tax planning in a generation.

Consider a couple with a £400,000 house, £200,000 in savings, and £300,000 in combined pension pots. Under current rules, their IHT-liable estate is £600,000. From April 2027, it's £900,000. After the £1 million combined threshold, they'd owe £0 today but could face a bill after the pension inclusion.

The planning response is already underway. Drawing down pension funds to spend, gift, or invest in ISAs (which remain outside the estate on death in most cases) is becoming a standard strategy. But be careful — drawing pension income increases your income tax bill, and the maths doesn't always work. Get advice specific to your numbers.

For 2025/26, pensions are still outside the estate. The window to plan around the 2027 change is narrowing.

Forget the myths about giving away your house and continuing to live in it — that's a gift with reservation and HMRC will include it in your estate.

Here's what genuinely works:

Spend it. The most tax-efficient <a href="/posts/estate-planning-guide-wills-probate-and-protecting-your-familys-future-in-202526">estate planning</a> strategy is enjoying your money. Every pound you spend is a pound HMRC doesn't tax at 40%. This sounds flippant but it's mathematically correct and emotionally underrated.

Give systematically. Use your annual exemptions every year. Start major gifts early to get the seven-year clock running. Document regular gifts from income meticulously.

Leave 10% to charity. If your will leaves at least 10% of the net estate to charity, the IHT rate drops from 40% to 36%. On a £500,000 taxable estate, that's a saving of £20,000 — and the charity gets the money instead of HMRC.

Use trusts carefully. Discretionary trusts can work for larger estates, but they come with their own tax charges (a 20% entry charge on amounts over the nil rate band, plus periodic charges). Professional advice is essential — the cost of getting trusts wrong is high.

Review <a href="/posts/life-insurance-and-inheritance-tax-how-writing-your-policy-in-trust-could-save">life insurance</a>. A whole-of-life policy written in trust can cover the expected IHT bill without adding to the estate. The premiums come from regular income (see the normal expenditure exemption above). This doesn't reduce the bill, but it ensures your beneficiaries aren't forced into a fire sale of assets to pay it.

For most families with estates between £500,000 and £2 million, the combination of annual gifting, pension drawdown planning, and the charity rate reduction is the practical toolkit. Elaborate trust structures are for estates well above that range.

Before 5 April 2026:

• Use your £3,000 annual gift exemption — and last year's if you didn't use it (£6,000 total)
• Make small gifts of up to £250 to other family members and friends
• Document any regular gifts from income — write down the amount, date, recipient, and the income it came from
• Review your will — check the 10% charity threshold if you're close to an IHT liability
• Check your pension beneficiary nominations — these are separate from your will and often forgotten
• Use your ISA allowance — ISAs don't reduce IHT (they're part of your estate), but they shelter investment growth from income and <a href="/posts/3000-cgt-allowance-vanishes-on-5-april-7-moves-to-make-before-it-does">capital gains tax</a> during your lifetime
• Consider bringing forward larger gifts if you're in good health and want the seven-year clock to start

The broader tax year-end planning window covers ISAs, pensions, and CGT too. But inheritance tax is the one where small annual actions compound over decades — and the frozen threshold makes every year of inaction more costly.

This article is for informational purposes only and does not constitute financial advice. Inheritance tax planning can be complex — consult a qualified financial adviser or solicitor for advice specific to your circumstances.