Millions of Britons could be missing out on a little-known inheritance tax exemption that allows some gifts to be passed on without any inheritance tax liability. New research from Canada Life found that 72% of UK adults do not realise that gifts made from surplus income can be exempt from inheritance tax calculations immediately.
The findings suggest many people may already be using the exemption without knowing it. According to research, almost a third (31%) of gifts made by over-55s over the past seven years were funded by spare or surplus regular income. However, experts have warned that people need to keep proper records if they want the exemption to apply.
John Chew, tax, trusts and estate planning expert at Canada Life, said: “With inheritance tax rules set to change from April 2027, more families are set to be caught in the IHT net and may be looking for strategies to manage their potential liabilities.
“For those fortunate enough to find themselves with surplus regular income that is not needed to cover living expenses, a powerful option is to gift that excess income regularly to loved ones.
“Under HMRC’s ‘normal expenditure out of income’ rules, any gifts that qualify as regular gifts from surplus income are immediately exempt from IHT. There is no need to survive seven years after making the gift, unlike many other forms of gifting.
“However, the exemption is relatively unknown and often underused because there are several strict conditions. The donor (or executors after death) must be able to evidence that all conditions are met. Without that evidence, HMRC may treat the gifts as potentially taxable.”
To qualify for the exemption, the gifts must come from income rather than capital.
John said: “The gifts should be funded from your net income, not by dipping into core capital such as savings or investments. This can include regular income you earn from sources such as pension income, interest dividends, or rental income after tax.”
The gifts must also form part of a regular pattern. John said: “Consistency is key. The gifts should be habitual and given on a regular basis. For example, a monthly bank transfer, or an annual gift each Christmas or birthday. One-off gifts are unlikely to qualify.”
On top of that, the payments must not affect the donor’s standard of living. John said: “If the gifts given to loved ones result in you having to dip into your savings to pay the bills, then the exemption would not apply.”
He added that anyone considering regular gifting should first assess their income and spending.
John explained: “Start by totalling all sources of regular net income, this could be from pensions, dividends, interest or rental income. Then add up all your usual living expenses. The difference between these figures is the potential surplus income that could be gifted.”
He also recommended setting up regular payments. John said: “Once you have decided on the amount you wish to gift on a regular basis and to whom, it should be automated, for example via a standing order. This helps to demonstrate a clear pattern of gifting to HMRC.
“As an extra precaution, many advisers suggest writing a letter to the recipient (or to their solicitor) stating that these payments are part of a planned series of gifts out of surplus income.”
Lastly, John stressed the importance of keeping records. He said: “Because the claim for the ‘normal expenditure out of income’ exemption is usually made after death, clear records are essential. HMRC form IHT403 includes a schedule which may be used to log these gifts as they are made.
“Keeping copies of bank statements, letters and a simple schedule of gifts can make life much easier for executors.”
He added: “Gifting from surplus income can be a highly valuable exemption, but the rules can be complex. A financial adviser can help determine whether this approach is appropriate and ensure the strict conditions are met.”