If you're giving your family money every month, perhaps towards the grandchildren's nursery fees or a bit towards a child's mortgage, you've probably been told it's free of Inheritance Tax as long as it comes out of your income. That's right. It can be. But there's a part of this rule that almost nobody mentions: the gift is only free of Inheritance Tax if somebody proves it. And that somebody won't be you.
In this article we'll look at what the rule actually says, who has to show it, what HMRC will ask them, and the simple records that make those gifts stand up.
Meet Brian and Sue
Brian and Sue are retired with two good pensions. For the last six years they've given their daughter £1,000 a month towards nursery fees and her mortgage. They've read about gifts from surplus income, so the seven-year rule doesn't worry them. Good for them. Six years at £1,000 a month is £72,000, and they're confident none of it will count towards their estate. Whether that's true depends on something that won't be looked at until they've both gone.
What the Normal Expenditure Out of Income Exemption Actually Says
The exemption comes from section 21 of the Inheritance Tax Act 1984. A gift is exempt if, or to the extent that, it is shown to pass three tests. First, it must be part of your normal expenditure, which in practice means regular, a habit rather than a one-off. Second, taking one year with another, it must come out of your income rather than your savings or capital. Third, after making it, you must still be left with enough income to maintain your usual standard of living. We've covered how the exemption works in more detail in our guide to gifts from surplus income.
The important word is shown. Not assumed, and not "everyone knew they could afford it." The exemption only applies when the evidence is there.
Who Has to Prove It
Here's the twist. Nobody checks any of this while Brian and Sue are alive. It's looked at after they've died, and the people who have to show it are their executors. Usually that's the children, quite possibly the same daughter who has been receiving the £1,000 a month. If you're not sure what that role involves, our guide to choosing the right executor is a good place to start.
Most families will never pay Inheritance Tax, but if your estate is anywhere near the threshold, this matters. If the exemption can't be shown, a big chunk of those gifts can be treated as ordinary lifetime gifts instead. Under the 7-year rule, ordinary gifts made in the seven years before death are counted back against your tax-free allowance, and anything over that allowance is taxed at 40%.
What HMRC Will Ask Your Executors
When an estate needs a full Inheritance Tax account, the executors complete form IHT403 to report lifetime gifts. If they want to claim that gifts came out of income, there's a page asking for your income and spending for each year the gifts were made: salary, pensions, interest, investments, rent, household bills, Council Tax, travel, holidays and so on. A lot of people are advised to fill that page in as they go, and that's good advice.
But look closely at what it asks for. It's a yearly summary. Income in, spending out, the surplus, and one total for gifts. It doesn't show who received what, or when, or that the gifts were regular. HMRC's own guidance says that "normal" means normal for the person making the gifts, and that in cases of doubt they look at how often the gifts were made, how much they were, who received them and why. None of that is on the form.
The form your executors fill in asks for less than HMRC may need to see.
Without proper records, that leaves your family trying to rebuild your finances after the event. Picture your daughter, a few weeks after the funeral, going through years of bank statements trying to work out what was regular and what wasn't.
The Records That Make Your Gifts Stand Up
The answer is simple, and it takes about ten minutes a year. Start with a short note at the beginning of the pattern, something like "From January, we intend to give our daughter £1,000 a month towards the nursery fees and the mortgage." Sign it, date it and keep it with your Will. HMRC's guidance says a single gift can qualify if it's intended to be the first of a pattern, but there has to be evidence of that intention, and a note like this is the simplest way to provide it. Writing it down is common good practice rather than a formal requirement, but it gives your executors something solid to point to.
Alongside that, keep a running gift log showing the date, who received the gift and how much. A notebook in a drawer is perfectly fine, as long as it's kept up to date and your executors know where to find it. Then, once a year, fill in the income and expenditure page of the IHT403 as you go, so the yearly figures are ready and the gift log sits behind them.
With those three things in place, your executors won't have to guess, and the exemption you've been relying on has the best chance of doing what you intended.
Getting It Right as Part of Your Wider Plan
Gifting from income is one of the most useful tools in Inheritance Tax planning, but it works best when it sits alongside the rest of your arrangements: your Will, your Lasting Powers of Attorney and any lifetime gifts you've already made. It's also worth making sure your executors know the records exist, so they're not left searching for them.
This article is general information about UK estate planning and does not constitute legal or tax advice. Everyone's circumstances are unique, so if you'd like to talk through yours, we'd love to help.
If you're giving to your family regularly and want to make sure it stands up, you can book a free, no-obligation 15-minute call with me here.
See our video on this topic: https://youtu.be/ASQniKV0nbY
