Regular gifts paid out of surplus income are exempt from Inheritance Tax with no cash limit, provided they form part of the giver’s normal expenditure, come out of income rather than capital, and leave the giver with enough income to keep up their usual standard of living. The exemption is claimed by the executors after death, so it stands or falls on the records that show the pattern of giving and the giver’s income and spending each year.

What are the conditions for the exemption?

Section 21(1) of the Inheritance Tax Act 1984 (IHTA 1984) makes a transfer of value exempt if, or to the extent that, it is shown:

  1. that it was made as part of the normal expenditure of the transferor;
  2. that, taking one year with another, it was made out of their income; and
  3. that, after allowing for all transfers forming part of their normal expenditure, the transferor was left with sufficient income to maintain their usual standard of living.

All three conditions must be met (IHTM14231). The words “it is shown” put the burden of proof on the person claiming the exemption, which in practice means the executors. Part of a single gift can qualify, with the rest being chargeable or covered by another exemption. GOV.UK confirms the exemption can be combined with any other allowance for the same person except the £250 small gifts allowance, so it sits alongside the £3,000 annual exemption.

What makes a gift “normal”?

Normal means normal for that person, not for the average person (IHTM14241). The leading case is Bennett v IRC [1995] STC 54, where Lightman J said normal expenditure is expenditure that accorded with the settled pattern of expenditure adopted by the transferor (IHTM14244). A pattern can be shown in two ways:

  • A sequence of payments, such as birthday money to each grandchild every year or a monthly payment towards a child’s rent.
  • A prior commitment or firm resolution that the giver then carried out, for example paying the premiums on a life policy written for someone else, or deciding to give a fixed share of income to their children.

HMRC regards three to four years as a reasonable span to show a pattern, though a longer period can be used if it helps (IHTM14242). A single gift can qualify if there is strong evidence it was intended to be the first of a series and further payments were realistically expected. HMRC looks at frequency, amount, the nature of the gifts, who received them and why (IHTM14243). One off gifts for a special purpose, such as clearing a child’s debts, are left out of the pattern.

What counts as income?

Income is not defined in IHTA 1984. HMRC’s view at IHTM14250 is that it is determined by normal accountancy rules, net of income tax, and is not necessarily the same as taxable income. Salary, pensions, rents, interest and dividends are typical sources. Several receipts that look like income are treated as capital:

  • The capital element of a purchased life annuity is excluded by section 21(3).
  • Withdrawals from investment bonds, such as the common 5% annual withdrawal, are usually capital even though they are regular.
  • Payments from a lifetime care plan bought with a lump sum are treated as a return of capital.

HMRC first looks at the income of the year the gift was made. If there is no evidence to the contrary, it considers that income becomes capital after about two years, so a large gift funded by several years of saved income is likely to be challenged (IHTM14250). In McDowall v IRC [2004] STC (SCD) 22 the Special Commissioners accepted that gifts made from income accumulated over about three years could qualify because the money was identifiably unspent income, but HMRC does not accept that the case means income keeps its character indefinitely (IHTM14251).

How is the standard of living test applied?

After deducting the normal gifts, the giver’s income must have been enough to cover their usual living costs. If they had to draw on capital to meet normal expenses, the test fails for the shortfall, although part of the gifts can still qualify (IHTM14255). It does not matter that the giver chose to spend capital while saving income; what counts is whether the income was sufficient. HMRC usually tests each year to 5 April and ignores abnormal one off gifts when doing the sum.

A change in circumstances can be relevant. If someone took on a commitment while they had surplus income and later had to pay unforeseen care fees, the exemption may not be completely lost. A commitment entered into when a fall in income was foreseeable does not get that protection.

Which gifts can never qualify?

  • Gifts of capital assets such as shares or jewellery, unless bought from income specifically to give away (IHTM14231).
  • Life policy premiums where the policy is linked to an annuity in a back to back arrangement (section 21(2), IHTM14235).
  • Transfers on death and deemed gifts when a reservation of benefit ends.

The exemption also does not stop the gift with reservation rules applying, so paying for something the giver continues to enjoy can still be caught. See gifts with reservation of benefit.

A worked example

Illustration only. Margaret, a widow, has a net income after tax of £52,000 a year from pensions and dividends. Her bank statements show living costs of about £30,000 a year. From 2021 she paid £1,000 a month into a savings account for her two grandchildren, £12,000 a year in total, and wrote to her daughter in 2021 saying she intended to keep doing so while she could afford it. In 2026 she also gave her son £40,000 from savings to help buy a house. She died in 2027.

The monthly payments follow a clear pattern backed by a written intention, came from income, and left her with £10,000 a year spare after living costs. They are exempt, however much they add up to. The £40,000 gift came from capital and does not form part of the pattern, so it is a potentially exempt transfer that counts towards the estate on her death, after any annual exemption available.

What records do executors need?

Executors claim the exemption on schedule IHT403 by answering yes to question 6 on page 1, which asks whether gifts should be treated as exempt as gifts out of income. Page 8 of the form then asks for the deceased’s income and expenditure for each year in which gifts were made:

Part of IHT403 What it asks for
Box 20, income Salary, pensions, interest including ISAs, investments, rents, the income element of annuities and other income, less income tax paid, giving net income
Box 21, expenditure Mortgages, insurance, household bills, Council Tax, travel, entertainment, holidays, nursing home fees and other costs
Box 22 Surplus or deficit income for the year, and the gifts made

To complete it convincingly executors normally gather:

  • bank statements showing the gifts leaving a current account that is fed by income, though HMRC does not require each gift to be matched to specific money (IHTM14250);
  • tax returns, pension statements and dividend vouchers for each year;
  • evidence of regular spending, such as utility bills, Council Tax and care home invoices;
  • any letter, note or standing order mandate showing the giver’s intention to make regular gifts.

Where the deceased did not keep a running record, rebuilding several years of income and spending is slow and often incomplete. A simple annual schedule kept by the giver, or by an accountant acting as attorney or executor, makes the claim far easier. HMRC can raise questions on the IHT400 account, and the checks it makes are similar to those in our enquiry checklist.

What are the common mistakes?

  • Treating any gift paid from a bank account as “out of income” without showing the income and spending figures.
  • Relying on a single large gift made shortly before death with no evidence it was the start of a pattern.
  • Counting bond withdrawals or the capital part of an annuity as income.
  • Assuming savings built up over many years still count as income.
  • Paying an attorney’s gifts without checking the power of attorney allows them, which defeated the first set of appeals in McDowall.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.