Gifting from Surplus Income

If your entire estate is left to your spouse, no IHT will be due and the nil rate band for the surviving spouse increases to £650,000.

Lifetime gifts can reduce the size of an estate for IHT purposes. However, gifts that come out of an individual’s capital (i.e. savings) will only reduce the value of the estate if the individual survives seven years from when they make the gift. If they do not survive seven years, the gift will be treated as remaining within the estate and may be subject to IHT. 

There is a valuable and often overlooked IHT exemption, which applies to normal expenditure out of income. A transfer is exempt if it is made as part of the normal expenditure of the transferor. The transfer must be made out of surplus income, but not capital. Taken together with all the transfers that form part of their normal expenditure, the transferor must be left with sufficient income to maintain their usual standard of living.

Gifts, which are normal expenditure out of income, are immediately exempt and there is no seven-year clock. These rules provide that individuals can make regular gifts out of their surplus income and provided the gifts do not impact their standard of living, then they will be outside the individual’s estate for IHT purposes.

As with all exemptions, there are conditions which must be met. The main rule is that expenditure must be out of surplus income. If the individual is making gifts and relying on savings to pay their bills, they won’t qualify for the exemption. The ‘income’ that should be used to make the gift is the income after bills and personal expenses. Rather than committing the surplus income to savings, it can then be used to make gifts.

Normal expenditure is defined as typical or habitual expenditure for a particular donor. The gifts should be made regularly (i.e. monthly or annually). The amounts don’t have to be the same each month or year or even to the same person, but gifting should be comparable year on year.

For example, the payment of nursery fees for your grandchildren out of your surplus pension or investment income would qualify. It does not need to be the same grandchild each month, it is enough that you are committing to making a regular gift to your “grandchildren” as a group. Similarly, the commitment to use 10% of your income to help with your children’s utility bills would qualify as normal expenditure. Again, it does not even have to be the same child, but the fact that you are committing to a regular sum for a defined purpose is sufficient.

The individual must maintain a record of the gifts to be able to evidence to HMRC that they meet the conditions for the exemption to apply.