The inheritance landscape in the UK 2025

Older generations in the UK now hold record levels of assets, ranging from property and pensions to investment portfolios.

Despite its reputation, Inheritance Tax (IHT) currently applies to only a small percentage of estates, roughly 4-5%. However, due to rising house prices and frozen thresholds, more families are being pulled into the tax net each year. IHT receipts are projected to reach £10 billion annually by 2028.

Here’s a quick overview of how the system works:

• You can pass on £325,000 tax-free, known as the nil-rate band.

  
  

• An additional allowance of £175,000 applies if you are passing on your main home to direct descendants.

  
  

• Couples can combine their allowances to shield up to £1 million from IHT.

  
  

• Any amount above this threshold is taxed at 40%, or 36% if 10% or more is donated to charity.

  
  

• Transfers to a spouse or civil partner are exempt from IHT.

  
  

• Certain business and agricultural assets may qualify for 50-100% relief.

While the basics are straightforward, planning can be complex. The rules are filled with conditions, time limits, and potential pitfalls.

In the following sections, we will cover how to navigate this challenging area, including ways to legally minimize IHT, how to structure your family setup, and how to avoid costly mistakes.

Tax-efficient planning

Inheritance tax might not apply to every estate, but when it does, the results can be ugly.

Fortunately, there are legal ways to reduce the hit. The trick is to start early, use the rules properly, and keep things structured.

Use gifts while you're alive

The most effective tool in inheritance tax (IHT) planning is the Potentially Exempt Transfer, or PET.

If you give away money during your lifetime and live for seven more years, that gift will be excluded from your estate entirely. However, if you pass away within three years of making the gift, it will be included in your estate and taxed at the full rate of 40%. If you die between three to seven years after the gift, the tax will decrease gradually through taper relief, ultimately reaching 0% by the seventh year.

Additionally, there are several annual exemptions that you can utilize, regardless of whether you survive the seven years:

• Annual Exemption: You can give away £3,000 each tax year without it being added to your estate for inheritance tax purposes. If you did not use last year's allowance, you can carry it forward for one year only.

  
  

• Small Gift Exemption: You can give up to £250 to as many different individuals as you like, provided you haven’t used another allowance for the same person.

  
  

• Wedding Gifts: Gifts made in connection with a wedding are exempt from tax within certain limits: £5,000 to a child, £2,500 to a grandchild, or £1,000 to anyone else. To qualify for this exemption, the gift must be made on or shortly before the wedding date.

• Gifts from Surplus Income: Regular payments made from your post-tax income (not from capital) are exempt from inheritance tax if they do not reduce your standard of living.

However, these gifts must be part of a consistent pattern and should be well documented rather than being one-off contributions.

While these allowances may seem modest, if used consistently and strategically, they can effectively transfer significant amounts of wealth without impacting your nil-rate band.

Cover the tax bill with life insurance

For families who expect to exceed the thresholds, life insurance can be used as a shield. A whole-of-life policy, held in a trust, can pay out just enough to settle an IHT bill.

Since the payout goes directly to beneficiaries, it's outside the estate. The idea is to prevent a fire sale of assets when the tax bill arrives.

Surplus gifts

For gifts made from surplus income, HMRC only recognises them as exempt if they meet certain criteria. These gifts must be genuinely regular, come from post-tax income (not capital), and should not reduce your standard of living.

You cannot simply give away a large sum at once and claim it as exempt. Instead, you need to provide evidence of a history of similar gifts or have a clear plan to repeat them annually. Keeping proper records and documenting your intentions is essential.

Additionally, these gifts must come from surplus income, meaning you should be earning more than you are spending each month. If your expenses exceed your income, which can be challenging during retirement, you won't be able to utilise this option.

Common pitfalls to avoid when gifting

One of the most common pitfalls is the gift with a reservation of benefit. This occurs when you attempt to give something away while still continuing to use or enjoy it. For example, this could involve signing your house over to your children while still living there rent-free.

HMRC (Her Majesty's Revenue and Customs) won't be tricked easily. In this scenario, the property still counts as part of your estate for inheritance tax purposes, even though you no longer own it on paper.

If the gift is made through a trust, and you continue to benefit from it, this could backfire significantly. You would incur a 20% charge on any amount above the nil-rate band, but the asset would still be included in your estate when you pass away, resulting in a 40% inheritance tax liability that you were trying to avoid.

Another common mistake is transferring assets to evade care fees. Local authorities have deprivation of assets rules when assessing means-tested benefits. If they suspect that you gifted your wealth to reduce your care costs, they will disregard the gift and treat you as if you still own it. This can leave you in a situation where you've given away something valuable but receive no benefit from it. This rule can apply for up to seven years after the transfer.

The key takeaway is this: for a gift to be effective, whether for tax or care planning purposes, it must be genuine. HMRC doesn’t care if your name is no longer on the deed if your slippers are still by the fire.

Trusts and structures

Thus far, we've explored methods for donating wealth in a clean, tax-efficient, and frequent manner. However, what if your goal isn't to give it away entirely?

Sometimes, the objective is to protect the money, control how it is used, or prevent it from falling into the hands of your children's future ex-spouses or other family liabilities.

In such cases, trusts and other legal structures are worth considering.

In the UK, the three main types of trusts used in estate and succession planning are bare trusts, interest-in-possession (IIP) trusts, and discretionary trusts. Each type offers different levels of control, tax implications, and strategic uses.

Bare trusts

A bare trust is the most straightforward type of trust. In this arrangement, the trustee holds assets in their own name, but the beneficiary has an absolute right to receive those assets once they reach adulthood. Essentially, it’s a delayed transfer of ownership.

Since the beneficiary is considered the legal owner of the trust assets, any income generated by the trust is taxed as their own income. If the trust is funded through a lifetime gift, that gift is classified as a Potentially Exempt Transfer (PET) for inheritance tax purposes.

This means that the gift will be removed from the settlor's estate if they live for seven years after making the gift.

Bare trusts are often used to manage savings or investments for children. They are simple, cost-effective, and transparent, but they do not provide any ongoing control over the assets.

Once the child reaches adulthood, the money in the trust becomes theirs without any strings attached. However, this also means that the assets offer no protection from potential issues such as creditors or divorce settlements in the future.

Interest-in-possession trusts

Interest-in-possession (IIP) trusts are more complex types of trusts.

These trusts allow a named beneficiary to receive income as it is generated—such as rental income or dividends—while the underlying capital is held for another person.

For instance, a parent might establish an IIP trust to ensure that a surviving spouse receives income for life, with the capital eventually passing to the children.

Typically, the life tenant (the individual entitled to the income) is responsible for paying taxes on that income, although the overall tax treatment involving trustees can be complicated.

IIP trusts are beneficial for protecting assets, as they enable an individual to benefit from the income without gaining control over the underlying capital. Additionally, in some cases, the residence nil-rate band—an extra allowance of £175,000 mentioned earlier in this newsletter—may still apply if a home is held in trust for children or grandchildren, depending on the specific structure of the trust.

Discretionary trusts

Discretionary trusts offer significant flexibility and control.

In these trusts, the trustees determine who receives funds and when. There isn’t a fixed beneficiary; instead, there is a pool of potential recipients, and the trustees manage distributions based on changing needs—for example, if a grandchild requires tuition fees or if a son loses his job.

However, this flexibility comes with significant costs.

Discretionary trusts are subject to what’s known as the ‘relevant property regime’—essentially, HMRC’s way of indicating that these trusts will be taxed heavily. As a result, they face:

• A 20% entry charge on amounts exceeding the nil-rate band (£325,000)

  
  

• A 10-year anniversary charge of up to 6% on amounts over the nil-rate band

  
  

• Exit charges of up to 6% when assets are distributed

Additionally, any income retained by the trust is taxed at a rate of 45%. Capital gains tax is also burdensome, as trusts receive only half the tax-free allowance that individuals enjoy.

Nonetheless, for families seeking long-term control, asset protection, or the ability to adapt to changing circumstances, discretionary trusts may be worth the extra administrative work and taxes.

At their core, trusts enable the separation of ownership from benefit, which can be particularly useful when an heir is too young, too reckless, or simply not ready. With a suitable structure—like discretionary trusts—they can also shield family assets from external risks such as bankruptcy and divorce.

Family investment companies (FICs)

Not all families are comfortable with the idea of placing their assets under the supervision of a trust. An alternative option is the Family Investment Company (FIC). This is essentially a private limited company that holds family wealth in the form of investments.

You can structure the shares strategically: parents retain the voting shares (allowing them to maintain control), while children receive non-voting shares (enabling them to benefit from any growth). It’s similar to being the CEO while your kids are silent shareholders.

The primary advantage of FICs is that they facilitate tax-efficient growth. Within the company, investment returns are subjected to corporation tax rates (currently between 19% and 25%) rather than the higher income tax or dividend tax rates that typically affect individuals who might need a trust—usually high earners.

If you gift shares in an FIC to your children, that transfer is classified as a Potentially Exempt Transfer (PET)—meaning it will only incur Inheritance Tax (IHT) if you pass away within seven years of the gift.

Furthermore, if you are in good health, creating an FIC may prove to be a more advantageous option than using a discretionary trust, which incurs an immediate 20% entry charge on any amount exceeding the nil-rate band, regardless of your lifespan.

As with trusts, establishing an FIC is intricate and it is advisable to seek professional assistance.

Family governance and succession planning

Good estate planning involves more than just clever tax structures and legal documents.

A finely-tuned trust structure won't protect wealth if heirs misunderstand their roles, mismanage assets, or start lawyering up before the funeral's over.

Establishing clear family communication

Many wealthy families face challenges when it comes to communicating their inheritance plans. A survey revealed that over 40% of high-net-worth families do not have an updated will or estate plan, and more than half have never openly discussed their inheritance plans with their heirs.

Although avoiding uncomfortable conversations may seem typical, it often results in confusion, resentment, and costly legal disputes in the future.

To begin addressing these issues, families can start by defining the core purpose of their wealth. This purpose could include maintaining a certain lifestyle, supporting future generations, or even funding philanthropic efforts.

Some families choose to draft a family constitution, which is an informal document outlining the family's values, shared objectives, and expectations. While it is not legally binding and does not require formal signing, the process of creating it can spark meaningful discussions and provide everyone with a common reference point.

Preparing heirs

Inheriting money can be simple, but managing it responsibly is a different challenge altogether. To address this issue, successful families are increasingly including younger generations in their financial decision-making.

Wealth advisers refer to this approach as "emotional mentoring.” It combines financial education with personal guidance, helping heirs to be prepared both financially and emotionally. This preparation equips them to handle complex family assets in a thoughtful and sustainable manner.

Don't let it burn in legal squabbles

Over the last ten years, inheritance litigation in the High Court has increased eightfold. These disputes often involve claims of undue influence, lack of mental capacity, or unfair distribution of assets. Such cases can become extremely costly; for example, one notable case saw legal fees completely depleting a £120,000 estate.

To minimise the risk of these issues, it’s important to maintain clear communication, make transparent decisions, and keep meticulous documentation. This includes regularly updating wills and trusts to ensure they remain valid and relevant despite changes in the law or family circumstances.

Final thoughts

Inheritance should not revolve around unexpected windfalls or enigmatic wills; it should focus on the choices we make. The extent to which your family benefits—versus what gets consumed by taxes or ends up in court—rests on your actions while you're still alive.

To ensure a smooth transition of your legacy, it’s essential to plan effectively, communicate openly, and engage the right professionals. Failing to do so could lead to a drawn-out legal situation reminiscent of a real-life Bleak House, where the only clear