Gifting out of income - the mechanics and the guidelines.

Effective estate planning involves more than just managing assets - it’s about preserving family wealth across generations, reducing unnecessary tax liabilities and ensuring that your legacy is protected. One of the most overlooked opportunities in the inheritance tax (IHT) landscape is the ability to make gifts out of surplus income, which, if structured correctly, can provide immediate IHT relief without using any of your nil-rate bands or requiring a seven-year survival period.

What is Gifting out of income?

Gifting out of income is an inheritance tax exemption that allows individuals to make regular gifts from their income without them being counted as part of their estate for IHT purposes. Unlike gifts from capital, which are potentially exempt transfers (PETs) and subject to the seven-year rule, gifts out of income are immediately exempt - provided they meet specific criteria set out by HMRC.

The key benefit is that if the criteria are met, the value of these gifts is permanently outside the estate from the moment they are made, with no requirement to survive seven years.

The criteria

To qualify as a gift out of income, HMRC requires that all three of the following conditions are met:

1. The gift must be made out of income - the gift must be made from the donor’s income, not capital. This includes salary, dividends, rental income, and pension income. Investment gains or withdrawals from investments (capital lump sums) do not count. Crucially, the donor must demonstrate that they had sufficient income to cover the gift in the year it was made. That means maintaining clear records of income streams and how the gift was funded.

2. The gift must be part of normal expenditure - the gift must form part of the donor’s habitual spending. In other words, there should be a pattern of giving that could reasonably be seen as normal. While there is no set timeframe, a series of regular gifts (such as monthly or annual transfers) is typically expected. A one-off payment is unlikely to qualify unless it forms part of a pattern that continues in subsequent years.

HMRC will look for evidence of intent (ideally recorded in writing) that the donor planned to make such gifts on a regular basis.

3. The donor must be left with enough income to maintain their usual standard of living - After making the gift, the donor must retain enough income to cover their usual living expenses. If the gift causes the donor hardship (a requirement to access their capital to meet day-to-day living expenses/costs) it will not qualify. HMRC may scrutinise expenditure and lifestyle to ensure this condition is met.

Recording and reporting

To ensure the exemption is successfully claimed, meticulous record-keeping is essential. The donor or their executors should be able to demonstrate:

• The source and amount of income received each tax year
• The amount and timing of gifts made
• A written statement of intent to make regular gifts (preferably made at the outset)
• That the gifts were affordable and did not require use of capital

Example 1: Monthly support to a child
Rod, a retired teacher, receives a pension income of £35,000 per year. His living expenses are around £25,000 annually. Each month, he gives £500 to his daughter to help with childcare costs. He keeps a written record of the arrangement and his bank statements show the monthly standing order. Because this gift is regular, affordable, and from income, it is exempt from IHT immediately.

Example 2: One-off gift
Helen, aged 80, receives rental and pension income of £50,000 a year. She gifts her grandson £20,000 to help with a house deposit. She has not made similar gifts in the past and does not intend to do so again. Although this gift was made from income, it is not part of normal expenditure and therefore would not qualify as exempt under this rule. It would instead be treated as a PET, subject to the seven-year rule.

Why this matters 

For many families, intergenerational wealth transfer is a key priority. Yet transferring significant sums during one’s lifetime often invokes the PET regime and its seven-year rule or triggers concern over loss of control. Gifting out of income offers an efficient, immediate alternative that does not reduce the donor’s lifestyle or disrupt long-term wealth structures.

Strategies include:

• Funding school or university fees for grandchildren
• Regular trust contributions for younger family members
• Annual payments to adult children to support their households or businesses
• Charitable giving on a consistent, tax-efficient basis

When used in conjunction with other exemptions (such as the £3,000 annual exemption or larger PETs) it can form part of a layered and effective estate plan.

In summary

Gifting out of income is a legitimate and powerful tool for individuals looking to reduce the tax liability on their estate without waiting the proverbial seven years. However, it must be approached with care, proper planning, and clear documentation.

As financial advisers, our role is to guide clients through the process, ensuring their gifting meets their overall objectives and is also both sustainable and compliant.

Although every effort has been made to ensure that the information provided in this article is accurate and correct, the information provided does not constitute any form of financial advice. We recommend that you take financial advice before making any financial decisions.