Only 2% of estates use this Inheritance Tax loophole

16 September 2025

Careful financial planning helps to ensure that you can live your desired lifestyle and achieve important goals now and in the future. However, as well as your own aims, you will likely consider your loved ones and the legacy you leave for them.

That is why Inheritance Tax (IHT) planning is so important.

Unfortunately, mitigating IHT could be more challenging in the future after chancellor Rachel Reeves announced that pensions would form part of your estate for tax purposes from 6 April 2027 onwards.

There is also much speculation that Reeves could announce further changes to IHT in the upcoming Budget, potentially limiting your estate planning options.

As such, it is crucial that you take advantage of all available IHT allowances and exemptions. Yet, many individuals overlook certain tax planning opportunities, such as the “gifts from surplus income” rule.

Indeed, according to Today’s Wills and Probate the most recent data available shows only 2% of estates used this rule to pass wealth to their beneficiaries and potentially mitigate IHT.

Keep reading to learn how the gifts from surplus income rule works and why your family could benefit.

You have an annual exemption of £3,000 in 2025/26

To understand how the gifts from surplus income rule works, it is important to first consider the basic IHT gifting rules.

In 2025/26, you have an annual gifting allowance, known as the annual exemption, of £3,000. Any gifts up to this threshold automatically fall outside your estate for tax purposes. This is an individual allowance so you and your partner could gift up to £6,000 a year between you without triggering an IHT charge.

Any gifts that exceed this annual allowance are “potentially exempt transfers”, which fall outside your estate provided you survive for seven years after transferring the wealth.

This is the “seven-year rule”.

If you pass away within seven years, your family may pay some IHT on the gifts and this is calculated on a sliding scale known as “taper relief”.

Gifts from surplus income are not typically subject to the 7-year rule

The gifts from surplus income rule allows you to make unlimited IHT-free gifts to your beneficiaries and these transfers do not count towards your annual exemption. They are also not subject to the seven-year rule.

In essence, under this rule, you could potentially gift an unlimited amount over the course of many years.

However, to qualify as gifts from surplus income, these transfers must meet certain criteria.

1. The gifts must be regular

The gifts typically need to be considered part of your normal expenditure and there must be a regular series of payments. This could be monthly, annually or biannually, for example, provided there is a clear pattern.

HMRC will assess each case separately and may consider payments across several years. As such, if there are only one or two sporadic payments, these gifts will likely be measured against your annual gifting allowance and may be subject to the seven-year rule, depending on the circumstances.

Additionally, the gifts usually need to be of a similar size to be considered regular. That said, if you transfer wealth to a beneficiary for a specific expense such as school fees or mortgage payments, variable amounts may qualify for the exemption.

For example, if you transferred £100 a month from your own income to each of your children over the course of many years, this could allow you to give away a huge sum under the gifting from surplus income rule.

2. You must make the payments from your income

The second stipulation is that you must make the payments from regular income. This might include your:

• Salary
• Pension income
• Trust income
• Dividends

Conversely, if you were to take wealth from a savings account or sell stocks and shares, then pass the funds to your loved ones, you likely would not benefit from the gifts from surplus income exemption.

3. The gifts must not affect your standard of living

Finally, you must be able to factor the regular gifts into your budget without sacrificing your own standard of living.

This can be difficult to define but HMRC may review your income and outgoings across several years to see if you appeared to reduce spending elsewhere, in order to make regular gifts to your beneficiaries.

Professional advice can help you overcome potential challenges when using this exemption

While the gifts from surplus income rule could help you reduce the size of your estate for IHT purposes, there are potential challenges to consider.

First, you may be concerned about how your beneficiaries will use smaller regular gifts compared with a large lump sum.

For instance, using the annual gifting exemption and seven-year rule to give a child wealth for a house deposit offers a clear way for them to work towards their financial aims and secure their future.

Yet, you may worry that gifting a small sum each month would amount to giving “pocket money” to your beneficiaries. These payments may be absorbed into their budget without making a marked difference to their long-term financial position.

Fortunately, we can help your family explore ways to leverage regular payments to build wealth, perhaps by contributing gifts from surplus income to their pension or investing, for instance.

You may also be apprehensive about reducing the size of your estate too much while alive, affecting your ability to fund your lifestyle during retirement. We can review your savings and use cashflow forecasting to determine what you can comfortably afford to pass on now, while also achieving your desired retirement.

Finally, we can help you ensure that your payments meet the necessary criteria, so your family does not receive an unexpected IHT bill after you pass away.

Crucially, we can assist with record-keeping so there is a clear paper trail of all regular payments. This documentation is incredibly important as your executor will need to demonstrate to HMRC that all payments qualify for the gifts from surplus income exemption.

Get in touch

If you are concerned about IHT and want to take advantage of the gifts from surplus income rule, we can guide you.

Email info@depledgeswm.com or call 0161 8080200.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

The Financial Conduct Authority does not regulate tax advice or cashflow planning.

Remember that taper relief only applies to gifts in excess of the nil-rate band. It follows that, if no tax is payable on the transfer because it does not exceed the nil-rate band (after cumulation), there can be no relief.

Taper relief does not reduce the value transferred; it reduces the tax payable as a consequence of that transfer.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.