Making Inheritance Gifts from Surplus Income

Inheritance Tax (IHT) applies to everything of an estate you inherit from a deceased relative, after deducting any applicable debts and liabilities from it.

  • The standard rate of IHT is 40% and it is only charged on the part of the estate that is above the threshold, known as the "nil rate band."
  • In the UK, the nil rate band for the 2022/2023 tax year is £325,000.
  • There are exemptions to IHT that you could be eligible for.

  • Many people fail to reap the benefits of this useful but under-utilised exemption, which applies to valuable assets that you gift to your heir during your lifetime.

    Here’s what you should know how to qualify by giving your gifts the right way.

    What Kind of Gifts are Exempted?
    If you want to make gifts to your heirs using surplus or excess income, there is a useful and underutilized exemption that allows gifts over the value of £3,000 per year to be made without them being considered part of your estate if you die within seven years of making the gift.

    This exemption is known as "Normal Expenditure out of Surplus Income." It is an effective way for those with higher incomes relative to their cost of living to gift part of their estate to future generations on a regular basis; especially if they want to distinguish these gifts from lifetime gifts of capital that have already been made or are being considered.

    How You Can Qualify
    To qualify for this exemption, you need to show that you plan to make regular gifts that will not affect your normal standard of living and that will come from income rather than capital. To determine if you have sufficient income to utilize this exemption, you should consider your net income after tax (such as from employment, pensions, dividends, interest, and rent) and review your normal expenditure (which is based on your individual circumstances and may fluctuate from year to year).

    It is important to carefully consider the conditions that must be met for gifts to qualify as "surplus" and "normal." Without careful planning, there may be room for doubt about the tax effects, so seeking professional financial advice is recommended. If you accidentally make a gift of capital, it could be very costly and result in a 40% inheritance tax charge if you die within seven years.

    Estate and Tax Planning
    You can carry forward your income for up to two years to determine how much surplus income you have available for gifting each tax year. It is helpful to keep financial records that allow you to calculate and offset expenditure against income, such as tracking the opening and closing balances on monthly bank statements. You should also consider creating a Memorandum of Intent declaring your intention to make regular gifts of excess income, which can be used to defend against challenges to the nature of the gifts.

    This method of tax planning can be particularly effective if you want to retain control of your capital while still making gifts to your heirs. It is important to consult with a financial professional to ensure that you are properly utilizing the "Normal expenditure out of surplus income" exemption and to determine the most appropriate gifting strategy for your individual circumstances.

    Estate planning is essential to make sure your wealth is protected for you and your family. By structuring your assets in a tax-efficient way, you can make sure everyone is provided for in the future. To discuss your options or any estate planning concerns you may have, please contact us.

    Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. Although endeavours have been made to provide accurate and timely information, we cannot guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No individual or company should act upon such information without receiving appropriate professional advice after a thorough review of their particular situation. We cannot accept responsibility for any loss as a result of acts or omissions.