A significant number of UK adults are missing out on a key inheritance tax (IHT) exemption, potentially leaving their estates more susceptible to taxation. New research indicates that seven out of ten individuals are unaware of the 'normal expenditure out of income' rule, which allows regular gifts made from surplus income to be immediately exempt from IHT.
This exemption stands apart from the more commonly known £3,000 annual gifting allowance or the 'seven-year rule', where larger gifts typically become exempt only if the giver survives for seven years after making them. The survey, conducted by insurer Canada Life, also revealed that approximately three in ten gifts made by over-55s in the past seven years were funded via this method, highlighting its practical application despite widespread lack of awareness.
For a gift to qualify under this lesser-known exemption, several conditions set by HMRC must be met. Crucially, the gifts must originate from the giver's regular net income, such as salary, pension, rental income, dividends, or savings interest, rather than from existing savings or capital. Executors of an estate must be able to demonstrate that sufficient surplus income was available to cover these gifts, and that the giving did not necessitate dipping into capital to maintain the giver's standard of living.
Furthermore, the gifts must form part of the giver's normal spending pattern, implying a degree of regularity. While there is no strict frequency, HMRC typically looks for evidence of an intention for the gifts to be ongoing rather than one-off payments. This could include monthly contributions to a child's household bills or annual payments towards a grandchild's education. The gifts should also be broadly consistent in size, though minor variations linked to fluctuating income or costs are generally accepted.
As IHT thresholds remain frozen and unused pension pots are set to become part of many estates from April 2027, more families could find themselves liable for this tax. Utilising legitimate exemptions like 'normal expenditure out of income' could become an increasingly vital component of estate planning for UK households aiming to mitigate their IHT liability. Individuals considering this approach are advised to keep meticulous records to demonstrate compliance with HMRC's conditions.