Gifts out of normal expenditure
Peter McGahan
Monday 26th October, 2026.
INHERITANCE tax planning has an unusual obsession with seven years. Make a gift, survive seven years and, broadly speaking, the gift can fall outside your estate.
Naturally, that leads to much excitement about calendars and considerably less excitement about dying before the appropriate date.
There is, however, a very useful inheritance tax exemption where the seven-year clock isn't the main event at all: normal expenditure out of income.
Used properly, it allows you to make gifts from surplus income which can be immediately exempt from inheritance tax. There isn't a fixed monetary ceiling on the exemption either. The limit is effectively created by your own income, expenditure and lifestyle.
That sounds wonderfully simple. Tax rarely rewards such optimism. S, there are three tests.
First, the gifts need to form part of your "normal expenditure". In layman’s terms, the tax man wants to see an established pattern of giving, or good evidence that you've made a firm commitment to create one. Regular monthly payments to children or grandchildren are obvious examples, but "normal" doesn't necessarily mean precisely the same cheque on precisely the same date each year.
Second, the gift has to come from income.
Third, having made those gifts, you need to have sufficient income left to maintain your normal standard of living.
All three matter.
Suppose your net annual income is £90,000 and your normal expenditure is £55,000. You therefore have a £35,000 surplus. If you establish a pattern of gifting £20,000 each year, while comfortably maintaining your lifestyle from the remaining income, this exemption could be extremely useful.
Compare that with somebody receiving £55,000 net income, spending £55,000 and deciding to give away another £20,000 each year by dipping into their savings.
Same gift. Very different tax position.
And this is where the word "income" becomes interesting.
Mr Tax Man commonly recognises earnings, self-employed profits, rental income, pensions, interest and dividends. Income doesn't necessarily have to be taxable either. Interest and dividends generated inside an ISA, for example, can be relevant income for these purposes.
But don't make the understandable mistake of assuming that because Mr Tax Man taxes something as income, it must therefore be income for this exemption.
An investment bond is a good example. Regular withdrawals can create an income tax charge, but that doesn't magically turn the underlying withdrawal into income for Inheritance Tax purposes. They are generally viewed as withdrawals of capital.
A regular return of your own capital is still your capital. Putting it on a monthly direct debit doesn't give it a moustache and allow it to sneak into the baldy face queue.
Pensions need care too. Ordinary pension income is a recognised income source. But withdrawing pension capital simply to manufacture money to give away is a different question. A large pension commencement lump sum shouldn't simply be labelled "income" because it came from a pension, as pension withdrawals have to be judged against the exemption conditions on their individual facts.
So when would I look closely at this exemption?
Typically, where somebody has genuinely more recurring income than they need. Perhaps substantial pension income, rental profits, earnings or investment income comfortably exceed their normal expenditure, and the surplus is simply accumulating each year.
That's the interesting bit. If £20,000 of unused income repeatedly lands in savings, eventually you have converted a useful planning opportunity into more capital sitting in your taxable estate.
Why wait?
It might instead support children's living costs, grandchildren's savings, regular pension contributions for family members and children, or another established gifting arrangement, provided the conditions are satisfied.
But don't impoverish yourself to save inheritance tax. That's the tax tail enthusiastically wagging the financial-planning dog.
Your lifestyle matters. Holidays, cars, eating out, household costs and everything else which constitutes your normal standard of living have to be considered. If your
gifts mean you subsequently need capital to support that normal lifestyle, the exemption may not be available in full.
Finally, keep records. Lots of them.
Your executors may ultimately have to demonstrate the pattern of gifts, your income and your expenditure after your death. HMRC's IHT403 form gives a useful indication of the information required, recording income, expenditure and gifts year by year. Have a look.
A beautifully constructed gifting strategy accompanied by records consisting of "Dad said it would be grand" isn't ideal evidence.
The best planning here is almost boringly simple: establish genuine surplus income, decide what you can sustainably afford to give away, create and document the pattern, and review it as your circumstances change.
You get to see your family benefit from the money while you're alive, rather than leaving your executors to explain afterwards why you kept accumulating money you never needed.
That's a much nicer seven-year plan.
I’m writing an inheritance tax guide. If you would like a complimentary copy, please email info@wwfp.net and one will be sent to you when it is ready.
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
