Regular gifts from surplus income and inheritance tax

Inheritance tax is charged on the estate (the property, money and possessions) of someone who has died, and any tax due is usually paid before the people inheriting receive anything¹. The nil-rate band, the amount an estate can pass on before tax starts, is £325,000². Against that background, one exemption matters more than most for families who help each other month by month: gifts made out of surplus income.

There is no limit to how much you can give away tax free under this exemption, as long as you can afford the payments after meeting your usual living costs³. The rule is often called normal expenditure out of income, and it is separate from the £3,000 annual exemption that most people know about⁴.

The catch is that the exemption is not automatic and it is not a formality. It has to be shown that the gifts were regular, that they came from income rather than savings, and that they left you with enough to maintain your normal standard of living⁵. That is why the paperwork matters as much as the giving.

Normal expenditure out of income: no upper limit on regular gifts

Most inheritance tax gifting rules come with a number attached. This one does not. There is no limit to how much you can give tax free, as long as you can afford the payments after meeting your usual living costs³. A parent who gives £500 a month to an adult child, or a grandparent who covers a grandchild's rent, is using the same exemption as someone giving far larger sums.

The exemption sits alongside the smaller allowances rather than replacing them. Outright gifts to any individual which do not exceed £250 in any one year are covered by the Small Gifts Exemption, and there are separate allowances for wedding gifts (up to £1,000, or £2,500 for grandchildren and £5,000 for children)⁸. Regular gifts from income are a separate exempt allowance in their own right⁸.

What makes the exemption powerful is also what makes it fragile. Because there is no cap, HMRC looks closely at whether the pattern of giving was genuinely funded from income and genuinely affordable. A gift that is really a one-off transfer of capital dressed up as a monthly payment does not qualify, however it is labelled.

Why these gifts escape the seven-year rule

Gifts you make more than seven years before your death will not form part of your estate, regardless of their value⁴. That is the rule most people have heard of, and it applies to larger one-off gifts. Money you give away in excess of the gifting allowances will fall outside of your estate if you live for seven years after making the gift¹⁰.

Gifts out of income do not need to wait seven years at all. Regular payments made out of excess income, which do not affect your standard of living, are normally exempt from inheritance tax¹¹. The exemption applies at the moment of the gift, so there is no taper, no seven-year clock and no reduction in the £325,000 nil-rate band².

There is one condition that catches people out. Gifts must be made without reservation, so the giver cannot benefit from them⁴. If you give money away but continue to enjoy the use of what you gave, HMRC can treat it as still belonging to you. A gift of income to a family member is usually straightforward on this point; a gift of a share of your home that you keep living in is not.

Surplus income or the £3,000 annual exemption: how each one works

These are two different tools, and they can be used together. The annual exemption lets you give away £3,000 in a tax year, and unused annual exemption can be carried forward one tax year only, allowing up to £6,000 in one year⁴. It is simple, needs no evidence of income, and applies whatever you give the money for.

The surplus income exemption works differently. It is based on your individual surplus income, not your household's combined income¹¹. That distinction matters for couples: one partner's comfortable surplus cannot be pooled with the other's to justify a larger regular gift.

A worked example shows how the surplus income test is applied in practice. If your monthly income is £3,000, your usual living costs are £2,500 and you give away £400 each month, you still have enough income left to cover your expenses¹¹. The £400 is comfortably within the surplus, so the exemption should hold. If the same person gave away £600 a month, the surplus would be gone and the gifts would be eating into the money needed for ordinary living.

Keeping records your executors can use

The exemption is claimed after death, by whoever deals with the estate, and it has to be evidenced. That means the record needs to exist before the person who made the gifts has died, because nobody else can reconstruct it reliably afterwards.

The practical approach is to keep the same discipline you would keep for any tax record. By keeping things separate, it will help you to keep records that you or your accountant will need to fill in tax returns each year¹². For gifting, that means a written schedule showing income coming in, normal spending going out, and each gift with its date and amount.

Donors wanting tax relief on charitable giving already have to keep a record of their donations if they want to take them off their total taxable income¹³. The same habit serves the surplus income exemption: a running log, kept with bank statements that show the payments leaving the account.

Where the exemption does not apply

The exemption fails in three common situations. The first is when the money comes from capital rather than income. Gifts out of income may also be tax-free, but they must come from income and form a regular spending pattern, and one-off amounts are unlikely to qualify¹⁴. Selling an asset and giving away the proceeds is not a gift from income, however regularly the payments are then made.

The second is when the giving affects your standard of living. It is possible in some cases to draw on unused income to make regular gifts if doing so does not affect your standard of living¹⁵. The test is not whether you have savings to fall back on, but whether your day-to-day life is unchanged.

The third is the care costs trap. If you give money away and later need means-tested care, the local authority can look at whether you deliberately deprived yourself of assets. Examples include giving away a lump sum as a gift, sudden unusual spending, transferring title deeds of property, using savings to buy possessions such as jewellery or a car which would be excluded from the financial assessment, or putting assets into a trust you cannot be removed from¹⁶. Regular affordable gifts from income are a different matter from stripping out capital, but the pattern of giving is one of the things that can be examined.

Pensions entering the estate: what changes for regular givers

For anyone funding regular gifts from pension income, the landscape changes from April 2027. From April 2027, money in pension drawdown will be added to the rest of your estate, meaning that it could be subject to inheritance tax if the total value of your estate exceeds the tax-free allowances⁷. The same shift applies to unused pension funds and death benefits more broadly.

That matters for the arithmetic of gifting. Pension withdrawals are treated as income or capital in the normal way, so they may affect means-tested benefits¹⁷. Regular payments from a pension count as income¹⁸. When you take a lump sum from a pension, 25% is usually paid tax-free, as long as the total amount of tax-free cash taken stays within the limit, and the other 75% counts as earnings for Income Tax¹⁹.

The practical effect is that a pension pot is no longer the straightforward inheritance tax shelter it once was. Someone who has been giving away surplus pension income each month may find that the remaining pot is now counted in the estate, which changes how much the regular gifting is actually saving. All pension contributions, including those made via salary sacrifice, remain exempt from income tax, subject to the annual allowance of £60,000²⁰.

Getting help

Inheritance tax is devolved in Scotland, and support is available through mygov.scot for anyone dealing with an estate there¹. Free, impartial guidance on pensions and retirement income is available from Pension Wise¹⁹. For anyone worried about debt or the effect of giving on their own finances, StepChange offers free debt advice, and retirement often means a reduced income which can make it hard to pay normal household bills²¹.