What is “gifting from income” and how could it help you mitigate Inheritance Tax?

Inheritance Tax (IHT) can significantly affect the wealth you leave to your loved ones. IHT is 40% as standard and the nil-rate bands – the amount you can leave to your beneficiaries IHT-free – are frozen until 2030.

So, as the value of your estate increases over time, your family’s chance of facing a charge also increases. That’s why understanding how to reduce your IHT liability is more important than ever.

Indeed, IHT receipts in the UK have been steadily rising in recent years and HMRC collected close to £7.5 billion in 2023/24. This trend is set to continue too, as the Office for Budget Responsibility predicts that IHT receipts will increase to £9.7 billion by the 2028/29 tax year.

Another important factor to consider is the upcoming change to pensions and IHT. From April 2027, pensions are set to be included in your estate for IHT purposes. This means that more of your wealth could be subject to IHT upon your death.

So, what could you do to help mitigate IHT, especially with the coming pension changes? Gifting from income could be a practical way to do this, so here’s what you need to know.

Gifting from surplus income can help you pass wealth to your loved ones tax-efficiently

Considering growing estates and the potential for pensions to add to this, many people are looking for ways to reduce their IHT liability. One potential strategy you could consider is gifting from surplus income. This money doesn’t form part of your estate, as it’s not included in your capital assets if you gift it or spend it.

Gifting from surplus income involves giving money directly from your regular income that you don’t need for living expenses or other routine financial commitments. This could be leftover income after you’ve covered your bills, saved for retirement, and accounted for all other monthly expenses. If you’re already retired, this could be income you draw from your pension or other savings.

Gifting from surplus income can play a part in a “giving while living” strategy, allowing you to put your wealth into your beneficiaries’ hands while immediately falling outside regular IHT concerns.

By gifting this income, you could reduce the size of your estate and potentially lower the IHT bill your loved ones could be facing.

Let’s consider an example:

Keith earns £3,500 a month. After covering his essential expenses, pension contributions, and even some luxuries such as a holiday, he has £500 remaining. Instead of saving this extra money, he decides to gift it to his son, Graham, as a regular monthly financial contribution.

Because this wealth doesn’t come from “capital,” such as savings or investments, and is made regularly, it immediately falls outside of Keith’s estate for IHT purposes. It won’t be considered a potentially exempt transfer (PET) and be subject to the seven-year-rule. See our previous blog for more details on how the seven-year rule works.

This allows Keith to route that money directly to a beneficiary. So, he could be helping Graham thrive now, all while reducing a future IHT bill.

Ultimately, by gifting from your income you could gift far larger sums of money than you might be able to under other IHT-efficient exemptions.

There are several restrictions and stipulations to keep in mind

However, before you start making gifts from income, it’s important to be aware that your gifts must meet certain strict criteria.

For these gifts to qualify, they must be regular payments directly from your income. These income sources could include:

• Pensions, including the State Pension
• Your salary
• Income from rental properties
• Business profits
• Dividends
• Interest earned on cash.

Additionally, it’s important to ensure you regularly gift the same amount, as your loved ones may need to prove that the gifts were “normal” after your death. In other words, there must be a regular pattern of payments as opposed to a single large amount. This is because HMRC may not recognise the payments as gifts from income if they’re irregular or not the same amount each time.

Some examples of regular payments as gifts could include paying for school fees or subsidising a fixed amount of rent.

Furthermore, for these gifts to be exempt from IHT, they must come from your surplus income and you must be able to maintain a normal standard of living after making the gift.

If you don’t meet these criteria, the gifts will likely be treated as PETs and could be taxable.

Practical tips to help with gifting from surplus income

Ensuring you comply with these rules can be tricky. Fortunately, there are a few steps you can take to help you make eligible gifts from surplus income and reduce IHT.

Firstly, consider writing a letter to the person or persons to whom you’re making the gifts. This letter should state your intention to establish a pattern and outline your gifting timeline. This letter could be useful for your executors – the individuals who will be responsible for calculating the value of your estate – when they come to establishing your intention.

It can be sensible to gift surplus income monthly for a prolonged period. This can both demonstrate your intent and prove that these were not funds you needed to maintain your lifestyle.

If you’re giving gifts to the same person, you can combine these gifts from surplus income with all other IHT allowances and exemptions, barring the small gift allowance (unlimited gifts of up to £250 per person). This means you can still use your annual gifting exemption (up to £3,000 in 2024/25) on a single person or split the value between several people, while also making gifts from income.

You can also still offer IHT-free gifts for weddings or civil partnerships. These will not affect your gifts from surplus income.

Speak to a Financial Planner to find out more

Gifting from surplus income can be a helpful way to reduce your IHT liability, but it’s important to understand the rules and regulations before you gift any of your wealth. Your Financial Planner can help you work through all the different restrictions and ensure that your gifts are structured appropriately to qualify for IHT relief.

Furthermore, we can help you assess your individual circumstances, work out an effective gifting strategy, and ensure you’re taking full advantage of all available tax reliefs and exemptions.

Email us at enquiries@pen-life.co.uk, or call 01904 661140 to learn more.

Please note

All information is correct at the time of writing and is subject to change in the future.

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

The Financial Conduct Authority does not regulate estate planning and tax planning.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.