HMRC tax rule means 'immediate exemption' for UK families

A new HMRC tax rule has emerged that allows UK families to pass money to children and grandchildren without it being subject to inheritance tax, potentially saving them thousands of pounds. According to recent findings, millions of families may be unaware of this provision, which offers immediate exemption from inheritance tax for certain types of regular gifts. The revelation comes from Which? Money, which has drawn attention to the potential benefits of these exemptions, particularly for those who regularly gift surplus income to family members. The exemption, known as "normal expenditure out of income," permits some regular gifts to avoid the usual seven-year waiting period required for them to become free of inheritance tax. However, the rules surrounding this exemption are stringent, and families must ensure they meet specific criteria to qualify. This provision is distinct from the more commonly known £3,000 annual gifting allowance and the seven-year rule, which applies to larger gifts. Research conducted by insurer Canada Life indicates that seven in ten UK adults are unaware that regular gifts made from surplus income might qualify for this exemption. These gifts must originate from income rather than savings or other forms of capital. Income sources eligible for consideration include salary, pensions, rental income, dividends, and savings interest. To qualify for the exemption, individuals must ensure that they retain sufficient income to maintain their standard of living. This encompasses household bills, daily expenses, and lifestyle costs such as holidays and travel. If making the gifts necessitates dipping into savings to cover these expenses, HMRC may challenge the validity of the exemption. For instance, an individual earning £3,000 per month with £2,500 in living costs could potentially give away £400 each month. However, if they gave away £800 and had to rely on savings to meet their expenses, the exemption could be questioned. Regular patterns of giving are essential for qualifying under this exemption. Payments should be part of a consistent giving schedule, such as monthly assistance with household bills, annual contributions toward school fees, or regular birthday gifts. Which? Money suggests that a pattern of giving over three to four years typically constitutes a reasonable timeframe, though a shorter duration might suffice if there is clear evidence of intent to continue the practice. Maintaining thorough records is crucial, as the exemption is usually claimed posthumously. Which? Money advises keeping detailed records of income, expenditures, and gifts, preferably through standing orders. A written statement outlining the intended payments can also be beneficial. Bank statements spanning the seven years prior to death can aid in proving the consistency and affordability of the gifts. The organization recommends using HMRC’s IHT403 form as a guide for documenting these gifts. With inheritance tax typically levied at 40% on the taxable portion of an estate exceeding the relevant thresholds, more families could face exposure to this tax as the thresholds remain unchanged. Additionally, unused pension pots are set to fall under the scope of inheritance tax starting in April 2027, adding another layer of complexity for families planning their financial futures.