Imagine leaving your loved ones with a hefty tax bill instead of the full inheritance you intended. It’s a grim thought, but one that’s becoming increasingly common. Inheritance tax is quietly catching more families off guard than ever before, and the rules are only getting trickier. But here’s the silver lining: there’s a little-known strategy that could save your estate thousands—or even hundreds of thousands—in taxes. And this is the part most people miss: it’s completely legal, and it’s called the ‘normal expenditure out of income’ exemption.
According to the latest figures from HM Revenue & Customs, a staggering 31,500 estates paid inheritance tax in the 2022-23 tax year, a 13% jump from the previous year (https://www.thetimes.com/business-money/money/article/surge-in-families-caught-out-by-inheritance-tax-p0qxt03zj). What’s worse? The Office for Budget Responsibility predicts that by 2030, 10% of all estates will be hit by this tax, double the current rate. That’s partly due to changes in pension rules and how farms or family businesses are taxed. But don’t despair—with smart planning, you can fight back.
Here’s the deal: Inheritance tax kicks in at a 40% rate on the value of an estate above £325,000. If you leave your main home to a direct descendant (like a child or grandchild) and your estate is under £2 million, that threshold rises to £500,000. Gifts to spouses or civil partners are tax-free, and married couples can combine their allowances for up to £1 million in tax-free transfers. But the real game-changer? Regular, planned gifting from your income can be entirely exempt from inheritance tax—if you do it right.
But here’s where it gets controversial: While this exemption is incredibly generous, it’s wildly underused. Fewer than 2,000 estates claimed it in the four years to 2022-23, according to NFU Mutual, with each saving an average of £52,650 in tax. Why? Some say it’s too complicated, requiring meticulous record-keeping and financial planning. Others argue it’s simply not well-known enough. Chris Etherington from RSM points out that without a financial adviser, many people aren’t even aware this option exists. And the confusion around what counts as ‘income’ doesn’t help.
So, how does it work? The ‘normal expenditure out of income’ exemption allows you to make regular gifts from your monthly income—think salary, pension, rental income, or dividends—without those gifts being subject to inheritance tax later. The key? These gifts must not lower your standard of living. For example, grandparents could regularly contribute to their grandchildren’s school fees without worrying about tax implications.
Here’s the catch: HMRC will scrutinize your gifting pattern. To qualify, gifts must be consistent in amount and frequency (at least once a year), and you’ll need to prove they’re made from surplus income. Keep detailed records of your living expenses—mortgage, bills, holidays, and more—to show you’re not dipping into capital to fund these gifts. A direct debit or a written statement of intent can also help establish a clear pattern.
And this is the part most people miss: If you give £5,000 every month but one month give £10,000, that extra £5,000 might not qualify. Similarly, gifts from savings or capital—like withdrawing from an ISA—don’t count. The income must be earned in the same tax year the gift is made.
To navigate this, download the IHT403 form from the government’s website. It’s what executors use to claim exemptions, and it’ll give you insight into what HMRC looks for. Tim Morris from Russell and Co warns, ‘Consistency is key. If you can’t prove a pattern, the gifts may not be exempt.’
Now, here’s the thought-provoking question: Is this exemption a clever way to protect your legacy, or does its complexity make it inaccessible to the average person? Should the government simplify these rules, or is it up to individuals to seek professional advice? Let us know your thoughts in the comments—this is one tax strategy that’s worth debating.
