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The normal expenditure out of income exemption allows you to give away any amount of surplus income completely free of IHT, provided the gifts form a regular pattern and you retain enough to maintain your standard of living. No annual cap, no 7-year wait. Yet surveys consistently show it is among the least-used IHT exemptions.
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This exemption is contained in section 21 of the Inheritance Tax Act 1984. It predates many other IHT planning tools and has never been capped or restricted. The Autumn 2024 Budget did not change it.
To qualify for the exemption, a gift must satisfy all three of the following conditions:
The gift must form part of the donor's normal (habitual) expenditure. "Normal" means there is a pattern of giving — not just a one-off gift. The pattern does not need to be identical every time, but there should be a consistent intention and regular practice.
A single large gift, even if made from income, will not qualify unless there is evidence of a pre-existing pattern. HMRC has challenged deathbed gifts made "from income" where no prior pattern existed.
The gift must be made from income, not capital. "Income" includes employment income, pension income, rental income, investment income (dividends, interest), and annuity income. It does not include capital gains, withdrawals from savings or investments, or drawdown of capital.
This is important: a regular gift funded by selling ISA holdings or drawdown from a SIPP (if the drawdown exceeds the income return) may not qualify — the source matters. However, pension drawdown that represents a return on the pension's invested capital is generally treated as income for this purpose.
After making the gifts, the donor must be left with sufficient income to maintain their normal standard of living. This is assessed on an ongoing basis — it is not enough to have surplus income in one year if other years show a shortfall.
HMRC looks at total income minus total normal expenditure (including gifts). If the result is positive — income exceeds all expenditure including the gifts — the condition is met.
Over 10 years this removes £300,000 from the estate — with no IHT and no 7-year waiting period. Compare that with the annual gift exemption of £3,000/year over the same period = £30,000.
HMRC requires executors to complete form IHT403 ("Gifts and Other Transfers of Value") at the time of death. This form includes a detailed schedule requiring:
Without records, executors cannot complete this schedule and HMRC may deny the exemption. This is the most common reason the exemption is lost.
Best practice is to keep a simple annual record: a spreadsheet showing income by source, normal living expenditure, and the regular gifts. Some financial advisers offer a template specifically for this purpose. The donor should prepare this record each year and keep it with their important documents.
To begin using this exemption, start making regular gifts as soon as possible — the earlier a pattern is established, the more robust the HMRC position. Key steps:
Even if the first year's gifts are modest, establishing the pattern early protects the position. It is far easier to defend a 5-year pattern of regular gifts than a single large transfer made shortly before death.
The normal expenditure out of income exemption stacks with other IHT exemptions. In the same year, you can also use:
Together, these form the core of a comprehensive gifting strategy for 2025/26.
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