New research suggests the vast majority of Britons are missing out on an inheritance tax exemption that allows unlimited gifts to be passed on free of any IHT liability, provided certain conditions are met. According to data from Canada Life, 72 per cent of UK adults do not realise that regular gifts made from surplus income can fall outside inheritance tax calculations altogether.
The findings carry particular weight given that inheritance tax rules are set to change from April 2027, when unused pension pots are expected to be brought into many estates for IHT purposes, a shift that will draw significantly more families into the IHT net.
What the Exemption Allows, and Who Is Already Using It Unknowingly
Known formally as the “normal expenditure out of income” exemption, the relief permits individuals to make regular gifts from excess income without triggering inheritance tax, and unlike most gifting strategies, there is no requirement for the donor to survive seven years after making the gift for it to become exempt.
Canada Life’s research indicates many people may already be taking advantage of this without knowing it. Nearly a third of gifts made by over-55s over the past seven years were funded from spare or surplus regular income, yet most donors and recipients are failing to keep the records HMRC requires to substantiate the claim.
John Chew, tax, trusts and estate planning expert at Canada Life, said: “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.”
He noted, however, that the exemption remains underused because of its strict qualifying 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,” he said.
Three Conditions Must Be Met, and Records Are Essential
To qualify, gifts must satisfy three specific criteria. First, payments must originate from income, such as pension income, dividends, interest or rental income after tax, rather than from savings or capital. Second, the gifts must form part of a consistent, habitual pattern; a monthly standing order or an annual birthday transfer would qualify, whereas a one-off payment would not. Third, making the gifts must not require the donor to draw on savings to meet everyday living costs.
Chew recommends that anyone considering this approach begin by calculating total net income across all sources, subtracting regular outgoings to identify the available surplus, and then automating payments to establish the necessary regularity in the eyes of HMRC.
Documentation is especially critical given that claims are almost always made after the donor’s death. HMRC form IHT403 includes a schedule for logging gifts as they occur, and retaining copies of bank statements and correspondence can ease the process considerably for executors.
“Gifting from surplus income can be a highly valuable exemption, but the rules can be complex,” Chew said. “A financial adviser can help determine whether this approach is appropriate and ensure the strict conditions are met.”
