We all know about the £3,000 annual gift allowance – which, let’s be honest, barely covers a family Christmas these days. But there’s another inheritance tax (IHT) rule that’s a bit of a hidden gem: the “normal expenditure out of income” exemption.
In short, if your income comfortably exceeds what you spend, you can give away the surplus – regularly – and it’s immediately free of IHT. No seven-year rule. No complex trusts. Just good records and a clear intention.
Why would you do this?
Because for many people, especially those with healthy savings and investments, the income just keeps coming. Dividends, pensions, interest, rental income – it all adds up, and the estate quietly grows year on year.
You don’t notice it until one day your ISA statements look smug, your savings account balance starts with a “3” (and not the good kind, if you’re thinking in six figures), and suddenly your estate’s well into IHT territory.
But if you’re happy that your capital already provides the comfort you need, why not use the income it generates to do something nice – like:
- Help the kids with their mortgages before they start thinking “generation rent” might apply to everyone;
- Pay the grandchildren’s school or uni fees while you’re around to enjoy the gratitude (or at least the occasional text);
- Fund the family holidays so everyone remembers you for the cocktails, not the tax bill.
The key is that it’s “normal” and from income
HMRC aren’t unreasonable – they just want to see that you meant to make these gifts regularly, that they came from income, and that you weren’t depriving yourself of Ferrero Rocher to do it.
A simple Letter of Intention does the job. Even if you save the income for a few months first (say, build up £20,000 and gift £10,000 twice a year), you’re fine – as long as you document it properly.
But be careful what counts as “income”
Not everything that lands in your account qualifies. “Income” means things like pensions, dividends, bank or bond interest, rental income, or regular drawings from a business. It does not include the sale or withdrawal of savings or investments.
So, for example:
- If your £20,000 ISA or Savings Bond hits its one-year anniversary and earns £800 of interest, that £800 is income you can gift tax-free. But the £20,000 you originally invested is capital – and gifting that would fall under the normal seven-year rule.
- Similarly, if you sell shares, cash in Premium Bonds, or move money from an old savings pot, that’s capital, not income.
The idea is simple: you can give away the fruit, but not the tree.
We’ve made that bit easy – you can grab our template “Letter of Intention – Gifts Out of Income” here:
Click here to open the template letter
If you’re not sure how it fits with your own finances – or if you’re worried your estate’s sneaking over the IHT threshold faster than you can say “frozen allowances” – give us a shout. We can help you work out what’s sensible, sustainable, and most importantly, tax-efficient.
