Most people know about the 7-year rule for inheritance tax gifts — but far fewer know about the Normal Expenditure out of Income exemption, which allows you to make unlimited IHT-free gifts from your surplus income with immediate effect. No waiting period. No upper limit. HMRC-approved.
What is the Normal Expenditure out of Income Exemption?
Found in section 21 of the Inheritance Tax Act 1984, this exemption allows gifts made from regular surplus income to fall outside your estate immediately. Unlike Potentially Exempt Transfers (PETs), which require you to survive seven years, these gifts are exempt the moment they are made — provided three conditions are satisfied.
The Three Conditions
First, the gifts must form part of your normal expenditure — they must be habitual and regular, not one-off payments. Second, they must be made from income, not capital — pension income, dividends, rental income, and savings interest all qualify, but selling investments to fund a gift does not. Third, the gifts must not reduce your standard of living — after making the gift, you must still be able to meet all your normal living expenses.
There is no upper limit on the amount you can gift under this exemption. If your pension and investment income leaves you with £3,000 per month surplus after all expenses, you could potentially gift £36,000 per year — all immediately exempt from IHT.
How to Establish a Compliant Gifting Programme
Start by calculating your annual income from all sources — state pension, occupational pension, dividends, rental income, and interest. Then list every regular outgoing, including housing costs, food, utilities, insurance, transport, and leisure. The difference is your surplus income available for gifting. Set up an automated bank transfer to the recipient on the same date each month or quarter — this creates the habitual pattern HMRC requires.
Why Documentation is Everything
The exemption is only as strong as your records. Keep a gifting diary recording every payment date, amount, and recipient. Prepare an annual income and expenditure summary. Write a letter of intent before making the first gift, confirming your ongoing plan. Your executor will need all of this to complete HMRC Form IHT403 during probate.