Gifts out of Surplus Income

Inheritance tax (IHT) receipts continue to rise year on year. In the 2024/25 tax year, HMRC collected a record £8.2 billion in inheritance tax, the highest figure ever recorded. With asset values remaining high, tax thresholds frozen and pensions coming into your estate in 2027 for inheritance tax purposes, this upward trend looks set to continue.
In the Autumn Statement 2025, the government confirmed that the inheritance tax nil rate band (£325,000) and residence nil rate band (£175,000) will now remain frozen until at least April 2031, along with many others. As a result, more families are being drawn into the inheritance tax net, often unintentionally, simply due to inflation and rising property values.

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While much inheritance tax planning focuses on lifetime gifts and the familiar seven-year rule, one of the most powerful yet frequently overlooked exemptions is the ability to make regular gifts from surplus income. When structured correctly, these gifts are immediately exempt from inheritance tax, with no seven-year survival requirement and no upper monetary limit. 

Used effectively, gifting from surplus income can significantly reduce the value of an estate over time while allowing individuals to support loved ones during their lifetime, often when that support has the greatest impact.

A changing landscape for family wealth

The ongoing cost-of-living pressures, high housing costs and financial challenges faced by younger generations have prompted many families to rethink how and when wealth is passed on.
Rather than leaving large sums to be taxed on death, many individuals are choosing to pass wealth down gradually and tax-efficiently. For those with strong and sustainable income in later life, gifting from surplus income can form the cornerstone of an effective inheritance tax strategy. 

Prioritising your own financial security

Before making any gifts, it is essential to ensure your own financial security is not compromised. This includes having confidence that you can meet:

• Your day-to-day living costs
• Inflationary pressures
• Potential future care costs
• Lifestyle and legacy objectives

Only once this has been established should gifting be considered. Cashflow modelling is often invaluable in identifying how much income is genuinely surplus and can be gifted without affecting your standard of living.

	Annual gifting exemption You can give away a total of £3,000 worth of gifts each tax year, known as your ‘annual exemption’. It can be gifted to one person or split between several people. If you didn’t use the exemption in the previous tax year, you can carry it forward for one year and combine it with the exemption for the current tax year and gift up to £6,000.
	Small gifts You can give as many small gifts of up to £250 per person as you like each tax year – just make sure you haven’t used another allowance (like the annual gifting allowance mentioned above) for the same person.
	Wedding gifts You can give a tax-free gift to someone who’s getting married or entering a civil partnership. The limits are £5,000 to a child £2,500 to a grandchild/ great grandchild £1,000 to anyone else. If you’re gifting to the same person, you can combine this wedding gift allowance with your annual exemption, but not with the small gift allowance. For example, you could give your child £5,000 as a wedding gift and an additional £3,000 using your annual exemption, all in the same tax year.
	Gifts to charities and political parties Gifts to registered charities and political parties are exempt from inheritance tax.
	Gifts from income You can make regular gifts from your surplus income as long as they don't affect your normal standard of living. Any gifts must form part of your normal expenditure, meaning that there must be an observable, regular pattern, should HMRC decide to audit any records. Examples of a gift out of regular income might include covering your child’s rent, or paying into a savings account for a child under 18. You can combine this exemption with other allowances (like your annual exemption) when giving to the same person - just not with the small gift allowance. For instance, you could pay your son’s monthly rent from surplus income while also giving him a one-off £3,000 gift using your annual exemption.
	Lifetime gifts Potentially Exempt Transfers (PETs) and gifts into Trust: Both are lifetime gifts for inheritance tax purposes and will be affected by the seven-year rule.

Annual gifting allowance, small gifts and wedding gifts

Before looking at the rules around gifting from surplus income, there are other inheritance tax exemptions available.
Each individual has an annual exemption of £3,000 per tax year. If unused, this can be carried forward one year only, allowing up to £6,000 to be gifted in a single tax year. For couples, this can amount to £12,000.
Other exemptions include:

• Small gifts of up to £250 per person, to an unlimited number of recipients, provided no other exemption is used for that individual
• Wedding and civil partnership gifts of up to:
  o    £5,000 to a child
  o    £2,500 to a grandchild or great-grandchild
  o    £1,000 to anyone else

Gifts to registered charities, qualifying political parties, and UK-domiciled spouses or civil partners remain fully exempt from inheritance tax.

Gifting from surplus income

The gifting from surplus income exemption allows individuals to make regular gifts that are completely exempt from inheritance tax, provided certain conditions are met. Crucially, these gifts fall outside your estate immediately, there is no need to survive seven years. 

The three key conditions

To qualify for this exemption, all three of the following conditions must be met:

Three Key considerations when gifting from income
Gifts must be made from income, not capital  Gifts must come from surplus income remaining after all normal expenditure has been met from income. Selling investments or withdrawing savings does not qualify.
Gifts must form part of your normal expenditure There should be a clear pattern or regularity to the gifts, such as monthly or annual payments.
Gifts must not affect your standard of living After making the gifts, you must still be able to maintain your usual lifestyle comfortably.

Provided these conditions are satisfied, there is no limit to how much surplus income can be gifted each year.

What counts as income?

Income for these purposes can include:

• Employment or self-employment income
• State Pension and private pensions (including defined benefit schemes)
• Rental income
• Interest and dividends from investments where income used for this purpose is identifiable and clearly distinguished from capital
• The interest element only from Purchased life annuities

Gifts must be made from net income, after tax.

Practical example

A retired couple has a combined net income of £70,000 per year from pensions and investments. Their annual expenditure is £50,000, leaving £20,000 of surplus income.
They decide to gift:

• £1,000 per month to their children, and
• £500 per month into savings accounts for their grandchildren.

As these gifts are regular, funded from surplus income, and do not affect their standard of living, the full £18,000 per year is immediately exempt from inheritance tax. Over ten years, this could reduce their taxable estate by £180,000, potentially saving £72,000 in inheritance tax.

The importance of record keeping

This exemption is assessed only on death, meaning it must be evidenced by executors. Clear record keeping is therefore essential and should include:

• A schedule of gifts detailing dates, amounts and recipients
• Bank statements showing income and payments
• Evidence of regularity, such as standing orders
• A simple written note outlining the intention to gift surplus income

This information will be required when completing form IHT403.

Lifetime gifts and Potentially Exempt Transfers (PETs)

Gifts that fall outside the available exemptions are usually classed as Potentially Exempt Transfers (PETs). These become free of inheritance tax if the donor survives seven years from the date of the gift, providing the 14 year rule is not invoked.

If death occurs within seven years, taper relief may apply:

Years between gift and death	Rate of tax on the gift
0 to 3 years	40%
3 to 4 years	32%
4 to 5 years	24%
5 to 6 years	16%
6 to 7 years	8%
7 plus years	0%

Taper relief reduces the tax payable, not the value of the gift, and only applies where gifts exceed the nil rate band.
Gifts into discretionary trusts are classed as Chargeable Lifetime Transfers (CLTs) and may be subject to an immediate inheritance tax charge if they exceed the available nil rate band.

Allowances Recap (2025/26)

Allowance Type	Amount
Annual Exemption	£3,000 (carry forward 1 year)
Small Gift Exemption	£250 per person
Wedding Gift - Child	£5,000
Wedding Gift - Grandchild	£2,500
Wedding Gift - Others	£1,000
Nil Rate Band	£325,000
Residence Nil Rate Band*	£175,000

*As confirmed in the Autumn Statement 2025, the nil rate band and residence nil rate band will remain frozen until April 2031. The residence nil rate band tapers away for estates valued over £2 million.

How can we help

Effective inheritance tax planning is about more than simply reducing tax. It’s about ensuring wealth is passed on in a way that aligns with your values, supports your family and preserves your long-term financial security.
We can help you:

• Build a personalised cashflow model to identify surplus income
• Structure regular gifting strategies that meet HMRC requirements
• Explore wider estate planning options where appropriate
• If you would like to understand how gifting from surplus income could reduce inheritance tax on your estate, speak with one of our expert advisers today.

Contact us to arrange a free initial consultation.

Arrange a free initial consultation

Investment returns are not guaranteed, and you may get back less than you originally invested. Past performance is not a guide to future returns.

The Financial Conduct Authority (FCA) does not regulate cash flow planning, estate planning, tax or trust advice.

This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.