How High Income Households can use Surplus Income for IHT Planning to Avoid the 7-Year Gifting Rule
Inheritance tax (IHT) receipts hit a record £8.2bn in the year to March 2025. With pensions due to be included in the taxable estate from April 2027, this figure is expected to rise further. If you and your partner have more income than you need to live on, now is the time to consider using the Normal Expenditure Out of Income (NEOOI) exemption to pass on wealth efficiently.
This powerful exemption allows regular gifts from surplus income to fall immediately outside your estate for IHT purposes, no seven-year rule applies. But the rules can be complex, and HMRC will only assess the exemption after your death. Here’s a streamlined guide to help you navigate the process.
Key Rules for Normal Expenditure Out of Income Qualification
To qualify, gifts must:
- Be part of normal expenditure
- Be made from income (not capital)
- Leave you with sufficient income to maintain your standard of living
Understanding Normal Expenditure
What is ‘normal’ expenditure?
Gifts should follow a clear pattern over time (e.g. monthly, annually). Regular gifts over a period of time will likely qualify and the longer the pattern exists, the more likely any claim would be successful. HMRC often looks for a 3–4 year history or a clear financial commitment like a standing order.
Must gifts go to the same person?
No. They can go to the same group (like grandchildren) or into a discretionary trust.
Do gifts have to be the same amount?
No, but they should be similar in size or purpose. Large one-off gifts may only partially qualify.
Do gifts need to be made at set intervals?
Not strictly. Monthly, quarterly or annual patterns are fine, as long as they’re regular and proportionate.
Defining Income
What counts as income?
Post-tax income from employment, pensions, dividends, rental income, and ISAs (if withdrawn). Only the interest part of a life annuity counts.
Can pension tax-free cash be used?
Yes, but only if withdrawn gradually. Large one-off withdrawals usually won’t qualify.
Do bond withdrawals count?
No. These are usually treated as capital.
What about reinvested or carried-over income?
Yes, if it’s kept uncapitalised (e.g. in a bank account). But after two years, HMRC may treat it as capital.
Can spouses share income for gifts?
No. Each person must have their own surplus. Separate gifts may be more effective.
Your Standard of Living
What is surplus income?
It’s what’s left after covering usual living expenses. Using capital to maintain lifestyle may disqualify the exemption.
What counts as living expenses?
Mortgage, bills, travel, insurance, holidays, etc. Large one-offs like new kitchens may not count.
How are expenses split between spouses?
Usually equally for shared bills. Personal expenses are assigned to the individual.
What if my lifestyle changes?
Temporary changes (e.g. redundancy) may not affect claims. Permanent reductions could.
Claiming the Exemption
Do I need to report gifts now?
No. Most claims are made after death using form IHT403. Trust gifts may require form IHT100 during life.
How is the exemption claimed?
Executors must provide records of your income, expenditure, and gifting for up to seven years. Good documentation is essential.
Next Steps for Smarter Gifting
For individuals and couples with surplus income, the NEOOI exemption is a powerful IHT planning tool. But it must be used consistently, with clear records and careful structuring. Stay within your true income, maintain your lifestyle and document every step.
If you’d like to explore gifting further, please get in touch by filling the form below or calling us on 01825 76 33 66.
HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.