Using the normal expenditure from income exemption

 As inheritance tax liabilities increase and, with the forthcoming pensions changes, the normal expenditure from income (NEI) exemption has become an important part of inheritance tax planning. 

Gifts that fall within the NEI exemption are treated as exempt from inheritance tax when made – the donor does not need to survive 7 years for the gift to fall out of account for inheritance tax. This is, of course, subject to HMRC agreeing the availability of the exemption when a return is made after the donor’s death. 

Gifts can be made directly to the recipients or, should the donor wish to retain some control over the destination of the gifts, via a trust. The NEI exemption can also be used to cover premiums for a life assurance policy in trust. 

Qualifying conditions for the NEI exemption 

There are three main conditions (see IHTM14231) that all need to be satisfied for gifts to fall within the NEI exemption: 

1. Gifts must be made out of the donor’s income. 
   Income includes income from employment or self-employment, pensions, property, dividends and savings income, including income from VCTs and ISAs. 
   Withdrawals from investment bonds, including the “income stream” from discounted gift trusts, loan trusts and/ or reversionary interest trusts, are treated as capital and, therefore, do not count towards the NEI exemption. Where such withdrawals are received, they cannot be used to ‘augment’ income to support the donor’s normal standard of living for the purposes of the NEI exemption (see below). 
   If Uncrystallised Funds Pension Lump Sums (UFPLS) are being drawn, HMRC has stated that all of this income may be taken into account “depending on the individual’s circumstances”. 
2. There must be an intention that gifts will be made regularly, although the amount of each gift can vary, based on the donor’s circumstances at the time. 
   Donors should consider setting out their intentions in writing and all gifts should be recorded. Donors could execute deeds of covenant under which they promise to make payments on a regular basis. This can be particularly helpful if the donor later loses mental capacity, as it provides evidence of their intentions and may enable those acting under a lasting power of attorney to continue making the regular gifts. In theory, provided the donor’s intentions are clear, a single gift could qualify for the NEI exemption if the donor then dies. 
3. Gifts must not cause a reduction in the donor’s normal standard of living, so any gifts must be made from surplus income over expenditure. 
   This could be a matter of conjecture, especially after the donor has died and can no longer provide background to the gifts, so record keeping is very important. 

Keeping records

Lifetime gifts need to be disclosed on an individual’s death. To help personal representatives successfully claim the NEI exemption, the donor should keep records including the date, amount and destination of each gift along with his or her income and expenditure at the time of each gift. 

HMRC’s Form IHT403 can be a useful way to record this information, not least as it is the form that personal representatives will use to claim the NEI exemption after the donor’s death. 

Where ‘joint gifts’ are being made, each donor should record gifts separately, detailing the gifts attributable to him or her along with his or her income and share of expenditure. 

Gifts made from a joint account 

Particular problems can arise when gifts are made out of a joint account as the identity of who actually made the gift may not be clear. HMRC’s position on joint accounts is set out in IHTM15042 and IHTM15043. This can be particularly relevant where a couple are setting up a joint life last survivor life assurance policy in trust. 

HMRC will, in most cases, adopt a pragmatic approach and treat gifts as made on a 50/50 basis unless there is evidence to the contrary. However, this position can change when a claim is being made that gifts fall within the NEI exemption. 

Because inheritance tax is a tax on individuals, HMRC reserves the right to test NEI against payments in and out of the joint account for the individual in question. 

In some cases, it might be easier to draw up a memorandum specifying the proportion of gifts being paid by each party, so that, in the event of death, the amount that is tested against the deceased’s surplus income for the purposes of the NEI exemption is clear. 

It may also be worth considering whether a partner with a dominant share of surplus income should alone make the gifts from an account in his or her sole name. 

If this approach were taken when setting up a joint life last survivor life assurance policy under discretionary trust where one has the dominant surplus income, it may be appropriate for that partner to be the sole policy owner and settlor so that he or she is treated as making all the gifts (premium payments) for NEI exemption purposes. 

However, thought would then need to be given to what happens if that partner dies first and premium payments need to continue. These would then need to be paid by the survivor who would, at that point, need to have sufficient surplus income to justify the NEI exemption on all continuing premium payments. It would also be appropriate to exclude the settlor’s spouse from being a potential beneficiary under the trust to avoid a gift with reservation of benefit at that time. 

Disclosure to HMRC 

In general, gifts made that a person considers to be within their NEI exemption do not need to be disclosed to HMRC when they are made. However, this is subject to a proviso that chargeable lifetime transfers (CLTs) do not cause the individual to exceed his or her nil rate band in a 7-year period. Should this happen, HMRC requires a return so that they can check whether the NEI exemption does actually apply. HMRC practice on this is set out in IHTM06106.

If you or someone you know would like guidance on succession planning or inheritance tax matters, contact us to arrange a free initial consultation.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions. The information in the article is based on current laws and regulations which are subject to change as at future legislations. 

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available.

The information in this article is correct as at 15/07/2026.

The Financial Conduct Authority does not regulate tax advice, trusts, will writing, Powers of Attorney or estate planning.