How to cut your Inheritance Tax bill with this little-known exemption

According to internal HMRC calculations published by the Telegraph, an additional 49,400 families are set to be dragged above the Inheritance Tax (IHT) threshold by April 2028.

This comes following the decision by the government to keep the IHT threshold at £325,000 – the level set in 2009 – until at least April 2028.

At present, the IHT threshold (the “nil-rate band”) for an individual is £325,000. If you are leaving your main home to a direct descendant, then you can benefit from an additional “residence nil-rate band” of £175,000. Consequently, a married couple can have a combined threshold of £1 million.

Everything over these threshold values could be liable to a tax rate of 40%.

This freeze has been compounded by recent rises in house prices, which may have further boosted the value of your estate.

As estates grow in value, you may find yourself among the 280,000 families already expecting to pay IHT who now face the prospect of a higher-than-expected tax bill due to this threshold freeze.

If you’re worried about the financial impact of these frozen thresholds, there are steps you can take to mitigate a potential IHT liability. One such powerful but underutilised way is the “gifting from income” exemption.

At present, the Telegraph reports that only 430 families in the UK are taking advantage of this exemption, but many more could be doing so.

Read on to learn exactly what this exemption is, and how you may be able to save thousands in IHT.

How the “gifting from income” IHT exemption works

The gifting from income exemption enables you to make regular gifts to loved ones. These gifts can fall outside of your estate for IHT purposes.

However, there are some important restrictions on how much you can gift, how regularly you can gift, and where the gifts can come from.

Firstly, all gifts must be from income. This means that these gifts cannot come from capital. For example, you could make regular gifts from surplus income you receive from pensions and investments once you have covered all your own expenses.

Secondly, any gifts you make must not affect your quality of life. This means that you must pay all regular living expenses before you make any gifts.

If you have a very high income and very low living costs, this does mean you can theoretically gift larger sums.

The third stipulation is that these gifts must be part of your normal expenditure. This means the gifts must be given on a regular basis and must be of a similar value each time. Some variation in gift value is allowed if your income also varies.

“Regular” can mean monthly or annually, but HMRC will expect to see a pattern of gifting over a few years.

Examples of payments that fall under the gifting from income exemption

To help you understand exactly which types of payments fall under the gifting from income rule, here are a few examples:

Quarterly payments to your children to cover the cost of your grandchildren’s education
Monthly payments to grandchildren with the intention of saving the money for a house deposit
Regular payments into a savings account for a family member.

Examples of gifts which would not fall under this rule include:

Investing in a grandchild’s business
A one-off payment of surplus income from several years (for example, surplus income earned over five years paid in one lump sum)
A one-off asset gift such as a new car
Payments from capital
Payments that limit your quality of life.

You may be able to benefit from this exemption

If you have an estate worth over the IHT threshold or believe your estate will exceed the nil-rate bands, you may be able to benefit from this exemption.

Giving regular gifts out of your surplus income allows you to reduce the value of your estate, thereby reducing the tax bill upon your death.

Your regular gifts do not always need to be to the same person or people. As long as you are regularly gifting a similar amount, your gifts can be to various individuals who fall within a category – for example, grandchildren.

If you are gifting from your income, your executors must have strong evidence to support a claim to use the exemption when you die.

This could include but is not limited to:

A letter to any gift receivers outlining your intention to give them regular gifts
Records of spending patterns to prove living expenses were sufficiently met in your lifetime
Record of regular gift payments to individuals or groups of individuals.

Get in touch

If you’re concerned about a potential IHT bill, we can help you devise an estate plan to ensure your wealth is passed on tax-efficiently.

Get in touch with us today by emailing [email protected] or call us on 01625 466360.

Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

Tax planning and trusts are not regulated by the Financial Conduct Authority.