Estate Planning and Inheritance Tax: Making the Most of Gifts Out of Income

With Inheritance Tax (IHT) thresholds frozen until 2030, effective estate planning has never been more important. Without proactive measures, many families risk a higher tax burden, reducing the value ultimately passed on to loved ones. By making use of exemptions and planning strategies, you can help preserve wealth across generations.

Current IHT Thresholds

In the 2025/26 tax year, IHT is charged at 40% on the value of an estate exceeding the nil-rate band allowance of £325,000. Where certain conditions are met, the residence nil-rate band provides an additional £175,000 allowance. These thresholds apply per individual, meaning married couples or civil partners can potentially shelter up to £1 million from IHT with careful planning.

Commonly Used Exemptions

There are several straightforward measures to reduce the taxable value of your estate:
•    Annual exemptions – Each individual can gift up to £3,000 per year free of IHT.
•    Charitable gifts – Donations to charities are exempt from IHT and may also reduce the rate of tax payable on the remainder of the estate.
•    Wedding gifts – Exemptions apply when making gifts in consideration of marriage.

While these allowances are widely used, one valuable measure is often overlooked: gifts out of income.

Gifts Out of Income

Making regular gifts out of income is a highly effective estate planning strategy. Such gifts can be immediately exempt from IHT if they meet certain conditions, whilst also allowing you to provide recipients with meaningful, ongoing financial support.

Conditions for Exemption

For gifts out of income to qualify as exempt from IHT, the following criteria must be satisfied:
1.    Source of funds – The gifts must be demonstrably made from your income (for example, salary, pension, or investment income), rather than from accumulated capital.
2.    Regularity – The gifts should form part of a settled pattern, or demonstrate an intention of regularity, rather than being one-off transfers.
3.    No impact on standard of living – The gifts must be affordable from surplus income and must not diminish your usual standard of living.

Practical Considerations

When implementing this strategy, it is important to ensure that gifts are sustainable in the long term and aligned with your overall financial objectives. Careful consideration should be given to whether such funds may be more appropriately reserved for other purposes, such as future care provision, maintaining flexibility in retirement, or meeting the costs of downsizing.
In certain circumstances, it may be advantageous to earmark gifts for a particular purpose. Examples include contributing to school fees for grandchildren or making regular payments into a Junior ISA, which they can access at age 18.

Importance of Record-Keeping

It is essential to maintain clear and accurate records of all gifts made, whether out of income or within your annual exemptions.
In relation to gifts out of income, such records will be of particular importance to your executors, who may be required to provide supporting evidence to HMRC when administering your estate. Comprehensive records not only assist in expediting the probate process but also help ensure that beneficiaries can receive their inheritance without unnecessary delay.