What is the "gifts out of normal expenditure" Inheritance Tax exemption?

Full answer

The normal expenditure out of income exemption is one of the most valuable but underused Inheritance Tax reliefs, because unlike most gift exemptions it has no upper monetary limit and takes effect immediately, with no need to survive seven years. **The three conditions that must all be met** To qualify, a gift must: form part of your normal, regular pattern of expenditure (a one-off large gift generally will not qualify, but an established pattern, such as an annual gift, can); be made out of income, not out of capital or savings that have built up over time; and leave you with enough income remaining to maintain your usual standard of living after making the gift. **Why this differs from the £3,000 annual exemption** The £3,000 annual exemption is a fixed cap available to everyone regardless of their income or spending pattern. The normal expenditure exemption has no fixed monetary limit at all -- someone with substantial surplus income could exempt many thousands of pounds a year through this route, provided the three conditions are genuinely met, far exceeding what the annual exemption alone would allow. **What counts as establishing a 'pattern'** HMRC generally wants to see evidence of a regular commitment, such as a standing order set up to make the same or similar gift each year, or at minimum a stated intention to continue the gifts along with at least a couple of years of actual gifts made. A single unusually large gift, even if made from income, is much harder to defend as 'normal' if there is no established pattern either before or intended after it. **Record-keeping is critical** Because this exemption is assessed by the executors after death (often years after the gifts were made), HMRC's own form (IHT403) specifically asks for a breakdown of income, normal expenditure, and gifts made in each relevant year. Without contemporaneous records of income, outgoings and the gifts made, it can be very difficult for executors to prove the exemption applied, and HMRC may instead treat the gifts as ordinary potentially exempt transfers subject to the seven-year rule. **Worked example** A retired person with a comfortable pension income of £40,000 a year and living costs of around £25,000 a year gifts £10,000 annually to their grandchild for school fees, doing so consistently for six years before their death. Because the gifts were regular, came from surplus income (not capital), and did not reduce their standard of living, the full £60,000 given over six years can potentially be exempt from Inheritance Tax immediately, without needing to survive seven years from each individual gift -- provided the records support this. **Practical tip** If you intend to rely on this exemption, keep a simple annual log of your income, essential and discretionary spending, and the gifts made, and consider setting up a standing order to help demonstrate the necessary regular pattern -- doing this from the outset makes it far easier for your executors to claim the exemption successfully after your death.

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