The gifts from income exemption is the most powerful — and most underused — inheritance tax planning tool. There’s no limit on how much you can give, as long as it comes from surplus income.
What Is the Gifts from Income Exemption?
Key Features
| Feature | Detail |
|---|---|
| Formal name | Normal expenditure out of income exemption |
| Legal basis | IHTA 1984 s.21 |
| Amount limit | No limit |
| Waiting period | None — immediately exempt |
| Who can use | Anyone with surplus income |
| When to claim | After death, via IHT403 form |
Why It’s So Powerful
Unlike other exemptions:
- No annual cap (£3,000 annual exemption is capped)
- No 7-year survival requirement
- Can give any amount that qualifies
- Immediately outside estate
- Works alongside other exemptions
The Three Requirements
For a gift to qualify, it must meet all three conditions:
1. Made from Income (Not Capital)
| Counts as Income | Counts as Capital |
|---|---|
| Salary/wages | Savings |
| State pension | Investments |
| Private pension income | Property |
| Rental income | Premium Bonds |
| Dividend income | Lottery winnings |
| Interest (if regular) | Pension lump sum |
| Annuity payments | Inheritance |
| Trust income distributions | ISA withdrawals |
The test: Would withdrawing this money reduce your capital or savings? If yes, it’s capital.
2. Part of Normal Expenditure
The gifts must be:
- Regular or habitual (not one-off)
- Committed or intended to continue
- Part of your normal spending pattern
What makes it “normal”:
- Standing order paying school fees every term
- Monthly transfers to children
- Annual birthday gifts of £1,000 each
- Regular premium payments on life insurance for others
What’s NOT normal:
- Random gifts when you feel like it
- One large gift without precedent
- Gifts that vary wildly in amount
3. Leaves Sufficient Income to Maintain Standard of Living
After making gifts, you must still have enough to:
- Pay normal bills and expenses
- Maintain your usual lifestyle
- Not need to dip into capital
Key point: You don’t need to be wealthy. The exemption works on the surplus between income and expenditure, whatever level that’s at.
How to Calculate Surplus Income
Annual Income Assessment
| Income Source | Amount |
|---|---|
| State pension | £11,500 |
| Private pension | £25,000 |
| Rental income | £8,000 |
| Dividends | £3,000 |
| Total Annual Income | £47,500 |
Normal Expenditure
| Expense | Amount |
|---|---|
| Council tax | £2,200 |
| Utilities | £2,400 |
| Food/groceries | £5,200 |
| Car costs | £3,000 |
| Insurance | £1,500 |
| Clothing | £1,200 |
| Entertainment | £3,000 |
| Holidays | £4,000 |
| Healthcare | £1,500 |
| Home maintenance | £2,000 |
| Other | £3,000 |
| Total Expenditure | £29,000 |
Surplus Available for Gifting
| Item | Amount |
|---|---|
| Total income | £47,500 |
| Total expenditure | -£29,000 |
| Surplus available | £18,500 |
This £18,500 could be gifted every year, completely IHT-free.
Examples in Practice
Example 1: Retired Couple Helping Children
| Item | Husband | Wife | Combined |
|---|---|---|---|
| Pension income | £30,000 | £20,000 | £50,000 |
| Joint expenses | £32,000 | ||
| Surplus | £18,000 | ||
| Gift to each child (3) | £6,000 each | ||
| Annual exempt gifts | £18,000 |
Over 10 years: £180,000 passes tax-free — no 7-year wait.
Example 2: High-Income Professional
| Item | Amount |
|---|---|
| Salary | £150,000 |
| Investment income | £10,000 |
| Total income | £160,000 |
| Tax paid | -£55,000 |
| Living expenses | -£60,000 |
| Surplus | £45,000 |
Could gift £45,000/year — £450,000 over 10 years exempt.
Example 3: Paying Grandchildren’s School Fees
| Item | Amount |
|---|---|
| Combined pension | £65,000 |
| Living costs | £35,000 |
| Surplus | £30,000 |
| School fees (2 grandchildren) | £28,000 |
| Exempt gift | £28,000/year |
7 years of school = £196,000 exempt — no waiting period.
Example 4: Premium Payments on Life Insurance
| Item | Amount |
|---|---|
| Income | £80,000 |
| Expenses | £50,000 |
| Surplus | £30,000 |
| Life insurance premium (in trust) | £12,000/year |
| Other gifts | £15,000/year |
| Total exempt | £27,000/year |
Record-Keeping Requirements
What to Document
| Record | Purpose |
|---|---|
| Annual income summary | Proves income sources |
| Bank statements | Shows money flow |
| Expenditure breakdown | Proves living costs |
| Gift records | Dates, amounts, recipients |
| Standing order evidence | Shows regularity |
| Tax returns | Third-party income verification |
Annual Record Template
Create a spreadsheet with these columns:
Income sheet:
| Month | Salary | Pension | Dividends | Rent | Other | Total |
|---|---|---|---|---|---|---|
| Apr | ||||||
| May | ||||||
| … | ||||||
| Total |
Expenditure sheet:
| Category | Apr | May | Jun | … | Annual |
|---|---|---|---|---|---|
| Housing | |||||
| Utilities | |||||
| Food | |||||
| Transport | |||||
| Other | |||||
| Total |
Gifts sheet:
| Date | Recipient | Amount | What For | Running Total |
|---|---|---|---|---|
How Long to Keep Records
Keep records for:
- Minimum 7 years (to cover any 7-year PET queries)
- Ideally indefinitely (executors need them after death)
- Store securely with will and estate planning documents
Common Questions
Can I Give Different Amounts Each Year?
Yes, but there should be a pattern or commitment. Better to:
- Commit to a fixed monthly amount
- Adjust once per year based on circumstances
- Document any changes and reasons
What If Income Varies?
| Situation | Approach |
|---|---|
| Bonus year | Don’t gift the bonus — it’s one-off |
| Dividend varies | Use average, or only gift minimum expected |
| Income drops | Reduce gifts to match new surplus |
| One-time windfall | Cannot gift this as “income” |
Can I Gift Accumulated Interest?
Accumulated interest that’s been building up in a savings account is capital, not income. But:
- Interest received regularly and gifted promptly = income
- Standing order setting up automatic transfer of interest = clearly income
What About Premium Bonds Prizes?
These are windfalls/surprises — not regular income. Not suitable for this exemption.
Is a One-Off Gift Ever Exempt?
No — by definition, one-off gifts can’t be “normal expenditure.” But you can start a pattern with intention to continue, even if death intervenes early.
The IHT403 Form
What Is Form IHT403?
- Completed by executors after death
- Claims the normal expenditure exemption
- Requires detailed income/expenditure evidence
- Attached to main IHT400 account
What Executors Need
| Information | Detail |
|---|---|
| Income sources and amounts | For years gifts were made |
| Expenditure breakdown | Normal living costs |
| Gift schedule | Every gift with dates/amounts |
| Evidence of pattern | Standing orders, regularity |
| Proof gifts from income | Not capital erosion |
Without Good Records
If you don’t keep records:
- Executors must estimate from bank statements
- HMRC may challenge the exemption
- Gifts might be treated as PETs instead
- IHT potentially payable if died within 7 years
Practical Tips
Make It Easy to Prove
| Action | Why It Helps |
|---|---|
| Use standing orders | Shows regularity automatically |
| Pay from current account | Income arrives, gift leaves |
| Same amounts each time | Clearer pattern |
| Annual review | Document any changes |
| Tell your executors | They need to claim it |
What to Avoid
| Mistake | Problem |
|---|---|
| Erratic gift amounts | Harder to prove “normal” |
| Gifts from savings | Disqualified — that’s capital |
| Reducing your lifestyle | Fails the “sufficient income” test |
| No documentation | Executors can’t prove exemption |
| Gift more than surplus | Excess comes from capital |
Combining with Other Exemptions
You can use gifts from income alongside:
- £3,000 annual exemption
- £250 small gifts exemption
- Wedding gift exemptions
- Gifts to charity
Example combination:
| Exemption | Amount |
|---|---|
| Annual exemption | £3,000 |
| Gifts from income | £20,000 |
| Small gifts (4 × £250) | £1,000 |
| Total exempt in year | £24,000 |
Getting Started
Step 1: Calculate Your Surplus
Review last year’s bank statements:
- Total all income sources
- Total all regular expenditure
- The difference is your potential gift capacity
Step 2: Set Up Regular Gifts
- Standing order from current account
- Fixed amount monthly or quarterly
- To children, grandchildren, or others
Step 3: Start Record-Keeping
- Create annual spreadsheet
- Update monthly or quarterly
- Store with important documents
- Tell executors where records are
Step 4: Review Annually
- Check income hasn’t changed significantly
- Adjust gifts if surplus changes
- Update records
- Ensure still within means
Professional Advice
Consider consulting a financial adviser or tax specialist if:
- Large amounts involved (£20,000+/year)
- Complex income sources
- Want formal documentation reviewed
- Part of larger IHT planning
- Any uncertainty about qualification