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Gifting of Excess Income: A Smart Way to Pass on Your Assets Tax-Efficiently

Published: 26/08/2025
Written by Curwens Solicitors

Some individuals in the UK often face a challenge: how to pass on their wealth to family and friends without triggering significant inheritance tax (IHT) liabilities. While many are familiar with the £3,000 annual gifting exemption and the seven-year survival rule for potentially exempt transfers (PETs), a lesser-known but highly effective relief lies in “the gifting of excess income” out of surplus income. This is one of the most powerful, and underused, IHT planning tools available under UK tax law.

For legal advice on any of the issues discussed, please call our solicitors today on 020 8363 4444 or complete our online contact form, and we will be in touch with you as soon as possible.

 

excess income 1

What Is Gifting of Excess Income?

The ability to gift regular surplus income without it forming part of the donor’s estate for IHT purposes is provided under Section 21 of the Inheritance Tax Act 1984. Unlike other gifts that may become chargeable to IHT if the donor dies within seven years, qualifying gifts made from income are immediately outside the estate, with no seven-year rule applying. However, specific conditions do need to be met.


In simple terms, this relief allows individuals to give away income they do not need to maintain their current standard of living, thereby reducing the value of their estate over time without risking an IHT charge.

Conditions for Exemption

To qualify for the exemption, a gift must satisfy three key conditions:

  1. It must be made as part of normal expenditure
    The gift must form part of a pattern of regular giving. That is either as part of an ongoing commitment or one that can be evidenced over time. Regular monthly or annual transfers, payment of school fees, or contributions to a child’s mortgage payments can all potentially qualify.

  2. It must be made out of income
    The gift must come from the donor’s post-tax income. This includes income from employment, pensions, dividends, rental income, or interest. The gift cannot come from capital.

  3. The donor must retain enough income to maintain their usual standard of living
    The gift must not result in the donor needing to dip into capital to meet their own living expenses. If a donor’s lifestyle is being supported by their capital after making the gift, the exemption may not apply.

Why Is This So Valuable?

This form of gifting is particularly useful for individuals who have high levels of recurring income. For example, receiving income from final salary pensions, investments, or rental properties and having B.

Because the gift is immediately outside the estate, there is no need to survive seven years for the gift to become exempt. This offers significant certainty and immediate tax efficiency, particularly useful for older individuals or those with health concerns.

Practical Considerations and Documentation

To claim the exemption, proper record-keeping is critical. Upon the donor’s death, HMRC requires proof that gifts met the conditions. Executors must complete Schedule IHT403, detailing:

  • The donor’s income and expenditure during the relevant years
  • Details of the gifts made (amount, recipients, and dates)
  • Evidence of regularity (e.g. standing orders or letters of intention)

Without good records, HMRC may challenge the exemption, treating the gifts as PETs or chargeable lifetime transfers.

Tips for Effective Use

  • Start early: The more established the pattern of gifting, the stronger the case for exemption.
  • Put it in writing: A letter stating your intention to make regular gifts can help demonstrate a deliberate pattern.
  • Review regularly: Monitor income and expenditure annually to ensure continued compliance.
  • Avoid gifting capital: Make sure the source of the gift can clearly be traced to income.

When Gifting Isn't Advisable

While attractive, this strategy isn’t suitable for everyone. Those whose income is only marginally above their living expenses, or who anticipate needing to fund care or future liabilities, should approach with caution. Gifting too aggressively may leave donors financially vulnerable.

excess income 2

Conclusion

Gifting out of surplus income is a powerful, HMRC-recognised method of passing wealth to the next generation in a tax-efficient manner. Unlike other IHT strategies, it offers immediate tax relief, certainty, and the flexibility to support loved ones during your lifetime.

 

With proper planning and documentation, this little-known exemption can play a crucial role in reducing IHT and ensuring your wealth benefits those you care about most. For affluent individuals with stable, excess income, this strategy is well worth incorporating into their estate planning; with the guidance of a qualified financial planner and solicitor of course.

Anne Stennett is the Head of the Private Client Department at Curwens

Please note that our briefings are for informational purposes only, and do not constitute legal advice.

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