Gifts out of Surplus Income – What You Need to Know
- Aled Burd
- Oct 1
- 3 min read
Inheritance tax (IHT) receipts reached a record £8.2 billion last year, up 10% in just 12 months, and more than double the amount collected a decade ago. With personal pensions due to be included in estates from 2027, the amount families pay in IHT is expected to rise even further.
Understandably, many people are now looking for ways to pass on their wealth more efficiently. While one option is to make a large lump-sum gift, these are only fully outside your estate if you survive for seven years after making them – often known as the seven-year clock.
There are several allowances and exemptions that mean some gifts are immediately exempt from inheritance tax and are not subject to the seven-year rule. Everyone has an annual gift allowance of £3,000, allowing gifts up to this amount to be made each tax year without any tax implications. You can also make small gifts of up to £250 per person. Additionally, certain wedding gifts are exempt, with the allowable amount varying depending on your relationship to the individuals getting married.
Another valuable but less well-known exemption is the ability to make regular gifts out of surplus income. In simple terms, if your income exceeds what you need to cover your usual living expenses, you can gift the excess to loved ones. These gifts are immediately exempt from inheritance tax and are not subject to the seven-year rule. Below, we’ll explain how the exemption works and what you need to do to ensure you meet the requirements.
Protecting your lifestyle
The rule only applies to genuine surplus income. Your normal living costs - such as household bills, holidays, leisure, and other day-to-day expenses - must be covered first. If making gifts requires dipping into savings or reduces your standard of living, the exemption is unlikely to apply.
What counts as income?
For these rules, income is the money you receive regularly, after tax. This might include your salary, pension income (including tax-free cash or taxable income), dividends from investments, rental income, or interest on savings.
The gift must be made from your ongoing income and not from selling investments or using savings you’ve built up over time. If you dip into savings rather than income, the gift is unlikely to qualify.
Example: If your pension and rental income provide £50,000 a year after tax, but you only need £45,000 to maintain your lifestyle, the £5,000 surplus could be gifted each year. Provided the gifts are regular and properly recorded, they would normally qualify as exempt from inheritance tax straight away.
Building a regular pattern
HMRC will usually look for evidence that gifts are part of a clear routine rather than one-off gestures. They don’t have to be every month, or always the same amount, but they should show a consistent rhythm over time.
HMRC usually accept the exemption once a regular pattern of gifting has been established, typically over three to four years. For example, setting up a yearly transfer to children, or paying school fees each term, can help build that record. By contrast, making an unusually large one-off gift that doesn’t fit the habit may not be accepted under the exemption.
Keeping good records
This is often the most important step. Executors usually claim the exemption after death, so they will need clear evidence that the gifts were regular, affordable, and made from income. Keeping simple notes, bank statements, or a spreadsheet can make things far easier later on.
This exemption can be a particularly powerful tool in the context of the changing inheritance landscape. As planning strategies evolve, with pensions becoming part of the estate, one example might be to draw a higher income from your pension than you require for your own needs and gift the surplus, taking advantage of this exemption.
At Magenta, we are closely monitoring the evolving inheritance tax landscape. As we approach 2027 and the government provides further clarity, we will review these changes with you in your annual planning meetings and consider whether this exemption could be a suitable strategy for your circumstances. In the meantime, if you have any questions, please don’t hesitate to get in touch.
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