With Inheritance Tax (IHT) thresholds frozen, asset prices rising, and most unused pension and death benefits set to fall within your estate from April 2027, you may be searching for more ways to pass wealth to loved ones tax-efficiently.
Yet, research suggests that many people are unaware of one useful strategy.
According to Canada Life, 72% of UK adults don’t know that regular gifts made from surplus income can be immediately exempt from IHT.
This could be especially useful if you have more income than you need and wish to support your family during your lifetime.
So, continue reading to learn how gifting from excess income works and why it may be more relevant than ever as the IHT treatment of pensions changes.
Most unused pension funds will be included in your estate in 2027
From 6 April 2027, most unused pension funds and death benefits will be included in the value of your estate for IHT purposes.
Historically, pensions have been treated as an efficient way to pass wealth to your beneficiaries, as they usually sat outside of your estate.
As a result, many chose to preserve their pension wealth and spend from other savings or investments first.
However, the upcoming rule change might mean you have to rethink your strategy.
If you have a particularly large pension that you don’t expect to use in your lifetime, this could increase the value of your estate and lead to a larger IHT bill for your beneficiaries.
Currently, IHT is normally charged at 40% on the value of your estate that exceeds your nil-rate bands.
For the 2026/27 tax year, the standard nil-rate band is £325,000. You may also benefit from the £175,000 residence nil-rate band if you pass a qualifying home to a direct lineal descendant, such as a child or grandchild.
Married couples and civil partners can usually pass unused allowances to the surviving partner, meaning they may be able to pass on up to £1 million without incurring IHT.
While this might seem like a significant allowance, your estate may be larger than you initially think if you include your pension and home, which are likely two of your largest assets.
Lifetime gifting can reduce the value of your estate
Gifting your money or assets during your lifetime can be an effective way to reduce the overall value of your estate for IHT purposes.
You may already know about some of the more common gifting exemptions.
For instance, you can typically give away up to £3,000 each tax year using your annual exemption. If you didn’t use it in the previous tax year, you may be able to carry it forward for one year.
You can also make small gifts of up to £250 to as many people as you like, provided you haven’t used another exemption on the same person.
Additionally, gifts to a couple for their wedding or civil partnership may be excluded from your estate, depending on your relationship to them. This includes:
- £5,000 to a child
- £2,500 to a grandchild
- £1,000 to anyone else.
Larger gifts can be treated as “potentially exempt transfers”, meaning they fall outside of your estate entirely only if you survive for seven years after making them. Otherwise, the rate of tax will be measured on a sliding scale known as “taper relief”.
Gifts from surplus income can be immediately exempt from Inheritance Tax
The gifting from surplus income rule works differently, as it allows you to make regular gifts from money you don’t need.
For these gifts to qualify, they usually need to form part of your usual expenditure, meaning there should be a regular pattern of giving rather than a one-off payment.
Moreover, you must make the gifts from your income rather than capital. This means you shouldn’t fund them by drawing from savings, selling investments, or using other assets.
And, finally, the gifts can’t affect your standard of living. You should still be able to meet your normal costs and maintain your lifestyle after making them.
If your regular gifts do meet these conditions, there is no fixed upper limit on how much you can give.
For example, you might use surplus pension income to make regular contributions to a grandchild’s Junior ISA, help adult children with mortgage costs, or pay towards higher education fees.
This could allow you to support loved ones now while gradually reducing the value of your estate.
It is essential to keep accurate records of any gifts
While gifting from surplus income can be beneficial, the exemption is usually claimed by your executors after you pass away.
This means they may need to provide evidence to HMRC showing the gifts qualified. As such, it is vital to keep accurate records.
You may want to keep details of:
- The date of each gift
- The amount gifted
- Who received the money
- The income source used
- Your regular income and expenditure at the time
- Evidence that your standard of living wasn’t affected.
Without clear records, it may be more challenging for your executors to successfully claim the exemption.
This could result in gifts being treated differently for IHT purposes, potentially increasing the tax due on your estate.
We could help you ensure gifts are affordable before you begin
While reducing IHT is helpful, you shouldn’t give away money you may later need.
Your Engage Wealth Management financial planner can use sophisticated cashflow modelling software to show how regular gifting might affect your long-term wealth under various scenarios.
This could help you understand how much surplus income you could afford to give away without putting your own financial security at risk.
If you’d like to understand how the pension IHT changes could affect your estate, or whether gifting from surplus income is a suitable strategy for you, then please get in touch.
Email us at [email protected] or call 01273 076 587.
Please note
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate cashflow planning or tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.
Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.
