Here’s a shocking truth: Inheritance tax could silently devour a significant portion of your hard-earned legacy, leaving your loved ones with less than you intended. But fear not—there’s a little-known strategy that could save them thousands, if not hundreds of thousands, in taxes. And this is the part most people miss: it’s not just about what you leave behind, but how you give while you’re still here.
According to the latest data 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? This trend is set to worsen. Changes to pension rules and the way farms and family businesses are taxed mean even more families will be ensnared by this dreaded levy. The Office for Budget Responsibility predicts that by 2030, one in ten estates will pay inheritance tax—double the current rate.
But here’s where it gets controversial: While the tax is 40% on estates valued above £325,000 (or £500,000 if you pass your main home to a direct descendant), many believe these thresholds haven’t kept pace with rising property values. Is it fair that families are penalized for wealth they’ve worked a lifetime to build? That’s a debate for another day. For now, let’s focus on what you can control.
With smart planning, you can significantly reduce the tax burden on your estate. One of the most powerful—yet underused—tools is the “normal expenditure out of income” exemption. This rule allows you to gift unlimited amounts tax-free, provided the gifts are made regularly from your income and don’t impact your standard of living. Think of it as a loophole for the generous.
How does it work? Let’s break it down. If you’re consistently giving a portion of your monthly income—say, to help your grandchildren with school fees or to support a family member—these gifts can be excluded from your estate entirely. The key word here is consistency. HMRC will scrutinize your giving history, typically looking back three to four years to ensure it’s a genuine pattern. So, if you’re giving £5,000 monthly, don’t suddenly gift £10,000 one month—that extra £5,000 might not qualify.
And this is the part most people miss: The gifts must come from income, not savings or capital. We’re talking employment income, pension payments, rental income, dividends, or savings interest. Withdrawing from your ISA or savings account? That won’t fly. Also, you must prove the income was surplus to your needs. Keep detailed records of your living expenses—mortgage, bills, holidays, even nursing home fees—to show HMRC you’re not dipping into your capital to fund these gifts.
Despite its potential, this exemption is vastly underused. NFU Mutual found that fewer than 2,000 estates claimed it in the four years to 2022-23, with an average tax saving of £52,650 per estate. Why? Here’s the controversial bit: Some experts argue the rule is too complex, requiring meticulous record-keeping and financial planning. Others say it’s simply a lack of awareness. But is it fair to blame the taxpayer when the system itself is so convoluted? That’s a question worth discussing.
To make this work, start by setting up a direct debit or writing a letter of intent when you begin gifting. Keep the amounts consistent, and ensure the gifts are made from eligible income sources. Familiarize yourself with the IHT403 form—it’s your roadmap to understanding what HMRC will scrutinize. As Tim Morris from Russell and Co warns, “Consistency is key. Without proper records, your gifts might not qualify.”
Thought-provoking question for you: Is the “normal expenditure out of income” exemption a fair tool for reducing inheritance tax, or does its complexity unfairly favor those with access to financial advice? Share your thoughts in the comments—let’s spark a conversation about how we can make this system work better for everyone.