A Freedom of Information request to HMRC by wealth manager Quilter shows that in the past three years, just 1,490 estates that paid IHT have used the “gifts out of surplus income” rule, which equates to less than 2 per cent of those that pay the tax.
Here’s how inheritance tax works, and how the “gifts out of surplus income” rule can be used to cut your bill.
It is applied at a flat rate of 40 per cent on estates worth over £325,000, but the system includes many loopholes, meaning the effective rate is often much lower.
If a home is included as part of the estate and it is left to someone’s children or grandchildren, the threshold goes up to £500,000.
How the ‘gifts out of surplus income’ rule works
One way that people limit their inheritance tax bills is via gifting.
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Gifts given less than seven years before you pass away may be subject to IHT, though the rate you pay is on a sliding scale.
If gifts are made regularly from surplus income rather than capital – such as savings or a home sale – they can be exempt from IHT immediately, without the need to wait for the seven-year rule to apply.
It just needs to be ensured that the gifts:
form part of the transferor’s normal expenditure, were made out of income, left the transferor with enough income for them to maintain their normal standard of living.HMRC requires evidence that the gifts come from surplus income, proof that the donor maintained their usual standard of living and a pattern of regular gifting, rather than one-off payments.
Why more could use the rule in the future
Rachael Griffin, tax and financial planning expert at Quilter, said: “Given the upcoming pension tax changes in 2027, we expect to see a sharp increase in the use of this exemption as more people look for ways to mitigate IHT liabilities.
“However, good record-keeping is absolutely essential. HMRC requires clear documentation proving that gifts were made from surplus income rather than capital, and that they do not reduce the donor’s standard of living. Seeking financial advice can help ensure compliance and maximise the benefits of this overlooked exemption.”
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