Definition
Gifts out of normal expenditure is an inheritance tax exemption that allows you to make unlimited regular gifts from your surplus income without them counting toward your estate—provided they don't reduce your standard of living.
This powerful exemption means your gifts are immediately outside your estate with no 7-year waiting period, making it ideal for retirees with pension income exceeding their living expenses.
What Does Gifts out of Normal Expenditure Mean?
Under Section 21 of the Inheritance Tax Act 1984, gifts out of normal expenditure provide immediate exemption from inheritance tax when three specific conditions are met. Unlike the £3,000 annual gift exemption, this exemption has no monetary limit—you can gift £10,000, £20,000, or more annually if the conditions are satisfied. The exemption is claimed by your executors after your death using form IHT403, which is why maintaining detailed records throughout your lifetime is essential.
The three conditions create a framework that ensures gifts come from genuine surplus income rather than depleting your capital or compromising your financial security. First, gifts must form part of your normal (habitual) expenditure—HMRC typically looks for a pattern of 3-4 years of consistent giving, though a single gift can qualify if you have documented commitment to future regular gifts. Second, gifts must come from income sources like pensions, salary, rental income, dividends, or interest—not from savings, ISA withdrawals, or other capital. HMRC considers income held for more than two years to have become capital. Third, after making the gifts, you must have sufficient income remaining to maintain your usual standard of living without dipping into capital for normal expenses.
Consider Margaret, 67, a retired teacher receiving £38,000 annual pension income with £26,000 living expenses. She gives each of her two daughters £500 monthly (£12,000 total annually). After establishing this pattern for 3-4 years, Margaret's gifts likely qualify because they come from her £12,000 annual surplus income (£38,000 minus £26,000), form a regular pattern, and don't affect her lifestyle. Over 10 years, Margaret removes £120,000 from her estate—potentially saving £48,000 in inheritance tax at the 40% rate—all without any 7-year survival requirement.
Contrast this with David, 72, who gives his son £30,000 from his savings account for a house deposit. This doesn't qualify as normal expenditure because it comes from capital (accumulated income), not current income flow. Even though David's savings originally came from income, HMRC treats money held for more than two years as capital. David's gift becomes a Potentially Exempt Transfer (PET), only fully exempt if he survives seven years.
The exemption proves particularly valuable for high earners and retirees with substantial surplus income. James, 58, receives £180,000 annual dividend income with £75,000 living expenses. He commits to paying £1,500 monthly into Junior ISAs for each of his three grandchildren (£54,000 annually). Despite just starting this pattern, his documented commitment via letter and standing orders shows habitual intent. Over 15 years, James could gift £810,000 immediately outside his estate—potentially saving £324,000 in inheritance tax—while maintaining his comfortable lifestyle with significant surplus remaining.
Record-keeping is critical because executors must prove qualification years later. Maintain detailed records showing your income sources (pension statements, dividend vouchers, rental income), living expenses (bank statements, bills), and gifts made (dates, amounts, recipients). Without these records, even qualifying gifts may fail when executors complete form IHT403. Many financial advisers recommend keeping a simple spreadsheet tracking income, expenditure, and gifts monthly—straightforward documentation that could save your family tens of thousands of pounds in unnecessary inheritance tax.
Common Questions
"Can I give my children £1,000 a month from my pension without paying inheritance tax?" Yes, if the gifts come from your surplus pension income and you maintain your usual standard of living after making them. You'll need to establish a regular pattern (HMRC typically looks for 3-4 years of consistency) and keep detailed records. Unlike other gifts, these are immediately exempt with no 7-year wait.
"How much can I gift under the normal expenditure exemption?" There is no upper limit—this is what makes this exemption so valuable. However, gifts must come from genuine surplus income (not savings), form a regular pattern, and not force you to reduce your standard of living. If you have £20,000 annual surplus income after all expenses, you could gift that entire £20,000 annually.
"Do I need to tell HMRC about gifts I make from my income?" No, there's no reporting requirement during your lifetime. However, your executors will need to claim the exemption after your death using form IHT403, which is why keeping detailed records of your income, living expenses, and regular gifts is absolutely essential for proving qualification.
Common Misconceptions
Myth: Gifts out of normal expenditure only apply to small amounts like birthday and Christmas presents.
Reality: This is completely wrong and likely stems from GOV.UK's oversimplified example. In reality, there is no upper limit. You can gift tens of thousands of pounds annually if it comes from your genuine surplus income and forms a regular pattern. Someone with £50,000 annual pension income and £30,000 living expenses could gift £20,000 per year indefinitely—far more than birthday presents.
Myth: I need to make gifts for at least 7 years before they're outside my estate for inheritance tax.
Reality: No—gifts qualifying as normal expenditure are immediately outside your estate. There is no 7-year waiting period. This is what makes this exemption so powerful compared to Potentially Exempt Transfers (PETs), which only become fully exempt if you survive 7 years. The key is meeting the three conditions: normal pattern, from income, maintaining standard of living.
Related Terms
Understanding gifts out of normal expenditure connects to these related concepts:
- Inheritance Tax (IHT): This exemption is one of several ways to reduce the 40% tax charge on estates exceeding £325,000.
- Lifetime Gift: Gifts out of normal expenditure are a specific type of lifetime gift that qualifies for immediate exemption.
- Annual Exemption: The £3,000 annual exemption can be used alongside normal expenditure gifts for even greater tax efficiency.
- Potentially Exempt Transfer (PET): Unlike PETs, which require 7-year survival, normal expenditure gifts are immediately exempt.
- Standard of Living: One of three critical conditions—you must maintain your usual lifestyle after making the gifts.
Related Articles
- Inheritance Tax Explained: Understanding how IHT works helps you appreciate why unlimited, immediately-exempt gifts from surplus income are such a valuable planning tool.
- 10 Ways to Reduce Your Inheritance Tax Bill Legally: Discover how normal expenditure gifts fit into a comprehensive strategy alongside other IHT reduction methods like trusts and charitable giving.
- Lifetime Gifting Strategies for IHT Planning: Learn how normal expenditure exemption compares to other gifting approaches and when to use each strategy.
- IHT Planning for Retirees with Pension Income: Essential reading for anyone with surplus pension income showing how to strategically gift while reducing IHT liability.
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Legal Disclaimer: This glossary entry provides general information about the gifts out of normal expenditure exemption and does not constitute legal or tax advice. Inheritance tax rules are complex, and whether specific gifts qualify for this exemption depends on your individual circumstances. For advice tailored to your situation, particularly for substantial gifts or complex income arrangements, consult a qualified solicitor or tax adviser.