Gifts Out of Income: A Powerful IHT Exemption—If It’s Properly Documented

Among IHT tools, few are as effective—and misunderstood—as gifts out of surplus income. When income reliably exceeds spending, regular gifts made from income can fall outside the estate immediately, rather than counting as Potentially Exempt Transfers that need seven years to wash out. Used well, this can move meaningful value out of the estate during life without undermining financial security.

What qualifies as “from income” and “regular”?

HMRC’s tests are practical: the gifts must be made from income (pensions, salaries, rental profits, dividends), not from capital sales; they must form a settled pattern; and they must not reduce the donor’s standard of living. Common examples include monthly support for adult children, regular school-fee contributions for grandchildren, or paying premiums on a life policy written in trust.

The phrase “settled pattern” doesn’t demand rigid amounts on identical dates, but consistency matters. An annual letter of intent and a standing order can make the pattern clear, while allowing adjustments if circumstances change.

Why documentation wins the day

In practice, this exemption is won or lost on paperwork. Executors often rely on information that maps to IHT403 (the lifetime gifts schedule to IHT400). Keeping organised records—income statements, bank evidence of the gifts, and a simple note showing income comfortably covered both living costs and the gifts—can save months of administration. Without those records, HMRC is more likely to treat transfers as PETs, bringing back seven-year rules and unnecessary complexity.

How it complements the 2027 pension change

Once unused pension funds enter the IHT calculation, there’s value in moving wealth out of the estate during life—but not at the expense of higher income taxes or financial stress. When income is comfortably in surplus, this exemption allows families to support heirs in real time while reducing the eventual IHT exposure on death. It often sits alongside measured drawdown, partial annuitisation, and insurance in trust.

Common pitfalls—and how to avoid them

• Dipping into capital. If capital is being liquidated to fund gifts, the exemption likely fails.
• Irregular transfers. One-off, large gifts are rarely “regular”; consider starting small and building a pattern.
• No audit trail. If it isn’t written down, it’s hard to prove. Keep a light but consistent paper trail.
• Over-generosity. Gifts must not reduce living standards; financial strain can unravel the position.

A simple way to start

Adopt a “document-as-you-go” approach: a letter of intent, a standing order that matches surplus income, an annual check-in on affordability, and a folder (digital or physical) with statements. That turns a powerful exemption into a reliable one.