A freedom of information (FOI) request has revealed just 2% of estates have used the gifts out of surplus income gifting rule; but its use could increase in the wake of the government’s pension reforms.
1,490 estates over the past three years for which data is available used the rule according to data requested by wealth and financial management advisors Quilter who say they expect this figure to increase significantly due to changes to upcoming proposals bringing pension death benefits within inheritance tax net.
Annual data on gifts out of surplus income:
| Tax Year | Number of Estates |
| 2019-20 | 500 |
| 2020-21 | 510 |
| 2021-22 | 480 |
| Total | 1,490 |
While pensions currently sit outside of IHT, allowing individuals to pass on their unused pension funds free of inheritance tax, from 6th April 2027 pensions rules change meaning unused pension wealth will become part of the taxable estate, making it liable for IHT at 40% on amounts exceeding the nil-rate band.
“With just 1,490 estates making use of this exemption in the past three years, it remains one of the most effective yet underutilised IHT reliefs available. 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.
said Rachael Griffin, tax and financial planning expert at Quilter.
Unlike other gifting strategies, gifts out of surplus income do not require the donor to survive for seven years for IHT purposes. Instead, provided 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.
it is immediately exempt from IHT.
But, warns Quilter, HMRC requires clear documentation to prove that gifts were made from surplus income rather than capital and that they did not impact the donor’s standard of living; hence it is currently an underused strategy due to the extensive record keeping required. HMRC demands that those claiming the exemption show:
- Clear evidence that the gifts came from surplus income rather than capital,
- Proof that the donor maintained their usual standard of living while making the gifts, and
- A pattern of regular gifting, rather than one-off lump sums.
“For those who can afford to make gifts from surplus income, this is an incredibly valuable strategy, as the relief applies immediately without needing to wait seven years, which is required for most other gifts above the £3,000 annual exemption. 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.”
concludes Griffin.
4 responses
Rachel from accounts is bound to stop this
I think the reason why this is not used more often, is because of the risk to the advisor.
If the record keeping is not up to scratch, or HMRC just decide that the gifts weren’t out of income (for whatever reason), not only does the estate have a fight on its hands, but also there’s a potential negligence claim against the advisor. You can easily imagine how the conversation will go:
> “You told my husband that these gifts were outside of IHT. HMRC says they weren’t outside and have charged full IHT on them. It’s your fault. We would never have done this if it wasn’t for your negligent advice. You owe us compensation!”
I have read this article with interest, what a small number of estates. Educating clients to use this exemption is key but also how to keep accurate records completing the IHT 403 table( which is horrid!) is so helpful to executors who are more likely than not the one’s who have to struggle to complete the table. Recording intentions to make regular payments is also helpful. I say this is something the life time tax planners need to have in their armoury to help estates save IHT and somehow get clients to keep a good record.
Except it’s not in the last 3 years is it? This data is 5 years old.
Why can’t HMRC provide statistics from last year?