Wealth
While that can be an effective strategy, it’s far from the only option.
One of the most valuable, yet least well-known, inheritance tax exemptions allows you to make regular gifts from your surplus income that can be immediately exempt from inheritance tax. For many families, this can provide an opportunity to support children or grandchildren while steadily reducing the value of their estate.
The gifts from surplus income exemption allows you to make regular gifts from your income, rather than your capital, without those gifts forming part of your estate for inheritance tax purposes.
Unlike many other gifting strategies, there is no financial limit on how much you can give, provided certain conditions are met.
For those with income that comfortably exceeds their day-to-day spending needs, this can become an extremely effective long-term planning tool.
Many people are familiar with the so-called “seven-year rule“, where larger gifts are generally treated as Potentially Exempt Transfers (PETs). If you survive for seven years after making the gift, it usually falls outside your estate for inheritance tax purposes.
Gifts from surplus income work differently.
Provided the exemption applies, the gifts are immediately outside your estate. There is no need to survive seven years for the exemption to take effect.
This distinction makes the exemption particularly attractive for individuals who wish to pass on wealth gradually throughout retirement.
HMRC sets out three key conditions.
Your gifts must:
All three conditions must be satisfied.
The emphasis on “normal expenditure” means the gifts should form part of a regular pattern. For example, making monthly, quarterly or annual gifts is generally much easier to demonstrate than making occasional one-off payments.
Just as importantly, the gifts should not affect your own financial security. Financial planning should always begin with ensuring your own retirement and future needs remain fully funded before considering gifts to others.
Income can come from a variety of sources, including:
The key principle is that the money being gifted comes from income you have received, rather than from selling investments or drawing on existing capital.
Many families use this exemption to provide regular financial support to loved ones during their lifetime.
Common examples include:
Rather than leaving wealth to be inherited many years in the future, gifting during your lifetime allows you to see the positive impact your support can have.
Imagine you have retired and receive pension income of £60,000 each year.
After covering your household bills, holidays and other regular spending, you consistently have around £12,000 left over each year.
Rather than allowing that money to accumulate in your bank account and increase the value of your estate, you could establish a regular gift of £1,000 each month to your children or grandchildren.
Provided the gifts satisfy HMRC’s conditions, they can fall immediately outside your estate while allowing your family to benefit today.
Over ten years, that could mean £120,000 has been passed to future generations without increasing your inheritance tax liability.
One of the most overlooked aspects of gifting is keeping accurate records.
Following your death, your executors are responsible for demonstrating to HMRC that gifts qualified for the relevant exemption. Without clear evidence, there is a risk that gifts could be questioned or included back into your estate.
Good records should include:
Maintaining this information can make the administration of your estate significantly simpler for your family.
Not necessarily.
Before making regular gifts, it is important to understand your future income needs, potential care costs and other financial objectives.
Many people understandably worry about giving away too much too soon. Others underestimate how much they can comfortably afford to gift.
This is where comprehensive financial planning becomes invaluable.
Using cash flow modelling, it is often possible to project your future income and expenditure under a range of scenarios, helping you understand how much you may be able to pass on while remaining financially secure throughout retirement.
Rather than relying on guesswork, gifting decisions can then be made with confidence.
Gifting should never be viewed purely as a method of reducing inheritance tax.
Done thoughtfully, it can allow you to support the people who matter most at the moments they need it most, whether that is helping a child onto the property ladder, contributing towards education costs or simply giving your family greater financial security.
The gifts from surplus income exemption is one of the most effective, yet least understood, tools available for achieving this.
With the right planning, it can form an important part of a wider strategy to preserve family wealth while ensuring your own financial future remains secure.
Every family’s circumstances are different, and the most effective gifting strategy will depend on your wider financial plan.
If you’re considering making gifts to children or grandchildren, or would like to understand how the upcoming inheritance tax changes could affect your estate, our financial planners can help you build a strategy that’s tailored to your goals.
Remember, all decisions should be considered in the context of your own personal circumstances.
And for a fuller discussion on gifting more generally you can view our recent Gifting wisely: The future of family wealth webinar.
You can reach us at info@thepennygroup.co.uk or on 0207 061 2345.
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HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
Estate planning is not regulated by the Financial Conduct Authority.
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