There are a number of ways in which you could reduce your liability to Inheritance Tax but one, often overlooked, way to is to make use of the ‘normal expenditure out of income’ exemption.

Why is it beneficial? 

This relatively straightforward exemption is valuable because if you meet the criteria, you will benefit from an immediate exemption from Inheritance Tax.

Unlike lifetime gifts that may be potentially exempt from tax, there is no seven year waiting period, meaning your Nil Rate Band (currently £325,000 per individual) would remain intact.

There is no set limit on the amount gifted provided that the gifts do exceed your excess income.  You can therefore use your excess income to, for example, pay for your grandchildren’s school fees or premiums on a life policy without needing to be concerned about tax

When does the exemption apply? 

The exemption will only apply if it can be demonstrated that certain conditions have been met.  These are as follows:-

  • The gifts must be made from income.  You must be able to demonstrate that the gifts were made from your excess net (post-tax) income.  Please note that this exemption will not apply to any gifts you make from income accumulated over several years, so you should only use excess income from the current tax year.
  • You must be left with enough income to maintain your usual standard of living.If you need to resort to your savings to meet your living expenses, you will not meet the criteria. Withdrawals from investment bonds, or using your lump sum cash payment from a pension will also not qualify.
  • The gift must form part of your normal expenditure. ‘Normal’ means what is normal for you. You should also establish a ‘settled pattern’ of giving and, although there is no set amount of time to demonstrate such a pattern, HM Revenue & Customs suggests that three or four years of reoccurring giving may be sufficient. Because this exemption is not given automatically and must be claimed, be sure that you keep a record of any gifts you make to enable your family to show you have met the above conditions during your lifetime.

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