Quick answer: IHT gifts out of surplus income are exempt if they come from genuine surplus income, form a pattern, and don’t reduce your normal standard of living. Keep detailed records to satisfy HMRC.

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Gifting money to loved ones is a meaningful way to share your good fortune, but when it comes to inheritance tax (IHT), not all gifts are treated equally. Many people in England and Wales want to help family or friends during their lifetime, yet worry about the tax implications. The “gifts out of surplus income” exemption is a powerful tool—if you use it correctly. Here’s how it works, how to qualify, and what records you need to keep to satisfy HMRC.

What Are Gifts Out of Surplus Income?

This exemption allows you to make regular gifts from your income, without them counting towards your estate for IHT purposes. The key is that these gifts must come from genuine surplus income—not from your capital or savings—and must not affect your usual standard of living.

For example, if your pension and investment income comfortably cover your living costs, and you have money left over each year, you can gift that surplus to family or friends. If you do this regularly and keep good records, those gifts can be exempt from IHT, no matter how long you live after making them.

How to Qualify for the Exemption

1. Demonstrate Surplus Income

You must show that your income consistently exceeds your usual expenditure. This means your day-to-day living costs, bills, holidays, and any other regular spending are covered, and the gifts come from what’s left over. HMRC will look closely at your finances, so be realistic about your living costs.

For instance, if your annual income is £40,000 and your total yearly expenses are £32,000, you have a surplus of £8,000. If you gift £6,000 of that to your grandchildren each year, you’re likely to qualify.

2. Establish a Pattern of Giving

The exemption is designed for regular, habitual gifts—not one-off windfalls. You need to show a clear pattern, such as annual birthday gifts, Christmas presents, or monthly transfers. The longer the pattern, the stronger your case.

A good example is Mrs D, who gifts £6,000 every year to her family for five years, all from her surplus pension income. Because she’s done this consistently, it’s accepted as exempt.

3. Keep Detailed Documentation

HMRC will only accept the exemption if you can prove the gifts were made from surplus income and didn’t affect your standard of living. You’ll need:

• Schedules showing your income and expenditure for each year

• Bank statements showing the gifts leaving your account

• Details of the gifts, including dates, amounts, and recipients

• Completion of IHT403 Section 3 (if your estate is subject to IHT)

A simple spreadsheet can be invaluable, listing your income, expenses, surplus, and gifts made. Attach supporting bank statements and keep everything up to date.

Common Pitfalls to Avoid

One-Off Large Gifts

A single, large gift—such as paying off a child’s mortgage—rarely qualifies. HMRC wants to see regular, habitual giving. If you make a one-off gift, it may be treated as a potentially exempt transfer (PET) and could be subject to IHT if you die within seven years.

Underestimating Living Costs

Be honest about your spending. If you claim a large surplus but your actual lifestyle suggests otherwise, HMRC may challenge your figures. Include all regular expenses, from groceries to holidays, and don’t forget occasional costs.

No Paper Trail

Without clear records, it’s very difficult to claim the exemption. If HMRC can’t see a pattern or can’t verify the source of the gifts, they may refuse the claim. Start keeping records now, even if you’re only just beginning to make gifts.

Real Example

Mrs D receives a pension and investment income that comfortably covers her living costs. For five years, she gifts £6,000 annually to her family, recording each gift in a spreadsheet and keeping bank statements as evidence. When her estate is assessed for IHT, her executors submit the records and complete IHT403 Section 3. HMRC accepts the gifts as exempt, reducing the estate’s IHT liability.

Practical Steps to Take

1. Review Your Finances:
   Work out your annual income and all regular expenses. Be thorough and realistic.

2. Decide on a Pattern:
   Choose a regular amount and frequency for your gifts—monthly, annually, or on special occasions.

3. Start Recording:
   Create a spreadsheet or written schedule showing income, expenses, surplus, and gifts. Keep copies of bank statements and any correspondence about the gifts.

4. Inform Your Executors:
   Let your executors know about the exemption and where to find your records. This will make their job much easier when the time comes.

5. Complete IHT403 Section 3:
   If your estate is subject to IHT, this form is essential for claiming the exemption.

Final Thoughts

Gifts out of surplus income are a generous way to support loved ones and reduce your estate’s IHT bill, but only if you follow the rules and keep good records. Regular, well-documented gifts from genuine surplus income are key. If you’re unsure, start small and build a pattern over time. Your family will thank you, and you’ll have peace of mind knowing you’ve done things properly.

Disclaimer: This article provides general information for educational purposes only. It is not legal, medical, financial or tax advice. Outcomes can vary based on your personal circumstances.