How much do you know about the normal expenditure out of income rule?

As families look for ways to mitigate future Inheritance Tax (IHT) liabilities, one strategy is the ‘normal expenditure out of income’ exemption.

This rule allows individuals to make regular gifts from their surplus income without the gifts being subject to IHT, either now or in the future.

What is the normal expenditure out of income rule?

The rule allows individuals to make gifts from their income, as long as:

• The gifts form part of your normal expenditure
• The gifts are made out of income, not capital
• After making the gifts, you are left with enough income to maintain your usual standard of living

If these three conditions are met, the gifts are immediately exempt from IHT, even if you die within seven years.

This is especially useful for higher earners, retirees with pension income, or anyone with regular surplus income looking to support family members or pass on wealth efficiently.

A window of opportunity with pensions due to face IHT

From April 2027, the Government will remove the current IHT exemption on pensions inherited after death.

This will increase the taxable value of many estates, potentially catching more families in the IHT net.

Using exemptions like the normal expenditure out of income rule becomes even more critical as individuals reassess their estate planning strategies to protect loved ones from unnecessary tax.

Examples of how the rule can be used

Let’s say you receive £80,000 annually in pension and investment income but only spend £50,000 to maintain your lifestyle.

You could gift £30,000 each year to children or grandchildren. If documented correctly, these gifts would be immediately exempt from IHT, no need to survive seven years or use your nil rate band.

Alternatively, a grandparent paying a grandchild’s school fees or funding a lifetime ISA contribution annually from surplus income could also benefit from this exemption.

Make sure you document everything

HM Revenue & Customs (HMRC) will only accept this exemption if clear records are maintained. You should document:

• Your total income each year (payslips, P60s, pension statements, dividend vouchers, etc.)
• Your annual living expenses
• The amount and regularity of the gifts made
• A written intention (e.g. a letter or note) to make these gifts as part of normal expenditure

We strongly recommend keeping this documentation up to date and safely stored, as it will be reviewed by HMRC during the administration of your estate.

The normal expenditure out of income rule is one of the most generous, yet underused IHT exemptions available.

In light of the 2027 changes to pension taxation, it is an ideal time to revisit your gifting strategy and explore how to take advantage of this exemption.

If you would like advice on whether you qualify and how to apply the rule to your circumstances, contact our team today.