The Gifts That Keep on Giving: Navigating Taxes for Generational Wealth

Inheritance tax has crept up on us. Many families who never expected to be caught by it are discovering that soaring property prices and frozen tax thresholds push their estates outside the tax-free allowance. 

That means 40% of the wealth you leave goes to the taxman, and not your loved ones – who probably need it more and certainly who you would prefer to have it.

The good news is that there are ways to ensure that your wealth goes to those you want – and one of the most effective, but little used is the “Gifts out of surplus income” rule. 

How much will the taxman take?

Upon death, if the value of your estate exceeds the £325,000 allowance, commonly known as the nil-rate band, any amount surpassing this threshold will be subject to Inheritance Tax (IHT).

If a home is included in your estate and a direct descendant inherits it, the allowance will be £500,000, thanks to the £175,000 “residence nil-rate band”.  This means married couples can get a combined allowance of £1m. 

Giving money away while you are still alive would reduce the amount in your estate, but the taxman is wise to this ruse. You can give away cash or assets during your lifetime to bring down the value of your estate, but unless you live for another seven years, your gifts will count as part of your estate when you die. There are some small allowances. You can give gifts of up to £3,000 a year, plus a £250 small gifts allowance. You can also give £5,000 to a child or £2,500 to a grandchild for wedding expenses. 

Go above those sums, and the taxman will treat the money you give when you are alive as part of your estate when you are dead.

However, the seven-year rule does not apply to gifts made out of excess income. The rule allows any taxpayer to give away unlimited sums of money without getting caught by IHT – as long as the money comes out of income, not capital. 

How gifts out of income work

There are some rules about giving in this way. Gifts must be regular. HMRC staff may look back over a period of at least three or four years to see if the gifts really are made on a regular basis. They must be made from surplus income and not capital. And they must not reduce your standard of living: you should be able to afford the gifts once you have paid your normal outgoings.

One example of acceptable gifts of income might be to cover a grandchild’s school fees. Gifts will be regular and substantial, but as long as you can afford them out of surplus income the taxman will accept them under the rule.

What exactly does ‘out of income’ mean?

The rules mean you can give away surplus income from employment, property, pensions, interest and dividends. You can’t sell up capital assets – although you might be able to gift jewellery or a car – and you can’t claim that gifts are made out of several years of accumulated income. You need to be able to show that you have genuine income coming in to cover the gifts that are going out.

HMRC will look at income in the year the gift was made to see if it was affordable. 

How to claim the exemption

If you can be generous while you are alive, your loved ones will be happy  – but you can’t leave it to them to sort out what might be tax exempt and what is not after you’ve gone. Your executor will need evidence to claim the exemption when they come to fill in the IHT forms. 

So, two things are essential.

The first is to keep thorough records. You’ll need to log your salary, pensions, investments, savings income, mortgages, insurance, household bills, travel costs, holidays and care home fees for the relevant years, as well as the details of the gifts themselves.

The second is to get some expert advice. Tax is complicated, and having an expert to help you through the maze of regulations could make things easier for you and your loved ones.

At Continuum we can help you set up gifts out of income – and discuss several other ways to keep the taxman away from your wealth after you have finished with it.

For a free initial consultation, call us today.

The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation on any suitable inheritance tax strategy, you should seek independent financial advice before embarking on any course of action.

The Financial Conduct Authority does not regulate taxation and trust advice or will writing.

Levels, bases and reliefs from taxation are subject to individual circumstances and may be subject to change.

Pass on unlimited amounts to your children – and never pay inheritance tax (

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