Inheritance tax planning: Using gifts and surplus income to protect your estate

More estates are paying Inheritance Tax every year. The Office for Budget Responsibility forecasts HMRC’s receipts to be approximately £14.3 billion by 2029/30, £2.5 billion of which they attribute to the policies announced in the last Budget in October 2024.

To reduce your overall estate and mitigate Inheritance Tax, making gifts is a popular mechanism, however some gift allowances are more widely known than others.

Gifts of capital

Individuals each have an annual allowance of £3,000 for gifts of capital which they may give away without any Inheritance Tax consequences. Broadly, any gifts above this annual allowance from which the donor does not survive 7 years will reduce their Nil Rate Band, increasing the Inheritance Tax liability. Other allowances are available e.g. for small gifts to individuals of up to £250 each and gifts for weddings or civil partnerships.

Gifts of excess/surplus income

There is also a lesser-used exemption from Inheritance Tax which allows you to make gifts out of your surplus income e.g. from your salary, pension, dividends etc. These are not gifts of capital so will not reduce your Nil Rate Band. However, various conditions need to be satisfied to successfully claim this exemption.

Standard of living

Firstly, the amount you may give away is based on the level of (post-tax) surplus income you have once your normal living expenses are accounted for. The gifts cannot therefore impact your usual standard living to be considered “surplus”. We recommend discussing this element with a qualified financial adviser to determine the amount that you may give away, bearing in mind your own needs. 

Regular pattern of gifting

Your living expenses will likely change year-by-year, or month-by-month, and the level that you may gift can also fluctuate with this and still qualify for the exemption. However, their occurrence will need to remain regular and show a pattern of gifting. This could be yearly, quarterly or monthly. Common patterns may be, for example:

1. Paying rent for your child monthly
2. Assisting with school fees term-by-term
3. Assisting with yearly premiums for private healthcare arrangements

Keeping clear records for HMRC

This exemption is claimed by your personal representatives when they report details of your estate to HMRC upon your death. Therefore, it is extremely beneficial to keep a record of all gifts you make, details of how these were made from surplus income, and inform your personal representatives where these records are kept.  

If you submit yearly Tax Returns, keeping your records together with these will make it easier for your personal representatives to collate the information.

Inheritance Tax Planning advice

Making gifts out of surplus income can therefore be an effective way to mitigate an Inheritance Tax liability; however, it requires careful planning and consideration. There are also more complex rules surrounding this exemption if you are planning on making gifts into a trust.

Please get in touch with our Wills, Trusts and Probate team to discuss your specific circumstances and long-term estate planning goals. Our expertise will ensure you have the confidence to make informed decisions and protect your legacy.