Families exploiting an under-the-radar exemption to elude Rachel Reeves's inheritance tax increase
In the UK, a little-known loophole known as "gifts out of surplus income" has seen a significant surge in usage, as families strive to mitigate inheritance tax (IHT) bills ahead of tighter rules. Even as Chancellor Rachel Reeves introduces tax reforms, this strategy remains an effective method for reducing IHT liability.
This exemption allows individuals to make unlimited gifts to others, provided the gifted amount comes from income (not savings or capital) and does not reduce their standard of living. These gifts are immediately exempt from inheritance tax, without the donor needing to survive seven years—unlike the general annual exemption or potentially exempt transfers (PETs).
According to recent data, the number of families using this exemption has nearly tripled, with gifts made under this rule increasing from £52 million in 2022–23 to £144 million in 2023–24. The appeal of this mechanism lies in its simplicity, lack of depletion of the annual gift allowance, and immediate tax efficiency, making it a valuable tool for tax planning.
Rachel Reeves's government has already enacted significant changes to IHT, such as subjecting the worldwide assets of non-domiciled individuals to UK IHT from April 2025. However, there is no indication that the "gifts out of surplus income" exemption itself is being targeted for closure in the immediate future.
From April 2027, unspent pension pots will be added to the value of estates for IHT purposes, potentially increasing the IHT liability for many families. This change will require executors to track down all pensions held by the deceased, complicating estate administration. While there is ongoing speculation about a UK wealth tax, Reeves has not confirmed any plans, and her previous public statements have ruled out a wealth tax on the richest in society.
The "gifts out of surplus income" exemption remains one of the most effective ways to reduce IHT exposure, especially as other reliefs come under scrutiny and the tax net widens. Families should continue to utilize this exemption where possible, while staying alert to potential future changes as the Treasury reviews the broader impact of its reforms.
In conclusion, the "gifts out of surplus income" loophole remains a robust and increasingly popular method for reducing inheritance tax liability, even as Rachel Reeves's government tightens other aspects of IHT, particularly for non-doms and pensions. Families should continue to utilize this exemption where possible, while staying alert to potential future changes as the Treasury reviews the broader impact of its reforms.
To realize the effectiveness of the "gifts out of surplus income" exemption in decreasing inheritance tax liability, one might consider diversifying their estate planning strategies by incorporating various types of gifts such as news subscriptions, finance literature, or educational videos. This approach not only streamlines the process of passing wealth to the next generation but also provides lasting benefits in the form of knowledge and resources. Moreover, as the government reviews its inheritance tax reforms, keeping abreast of business news pertaining to potential alterations in the loophole can be essential in maintaining a strategic financial outlook.
