New freedom of information data from HM Revenue and Customs (HMRC), collected by Quilter, the wealth manager and financial adviser, reveals that just 1,490 estates over the past three years for which data is available have used the gifts out of surplus income gifting rule.
This equates to less than 2% of inheritance tax (IHT) paying estates. However, this figure is expected to increase significantly due to changes to upcoming proposals bringing pension death benefits within inheritance tax net – making this type of planning much more useful.
With IHT receipts reaching record highs and sweeping changes to the tax treatment of pensions due from 6 April 2027, this strategy is set to become one of the most useful but still underused ways to pass on wealth efficiently.
Annual data on gifts out of surplus income:
| Tax Year | Number of Estates |
| 2019-20 | 500 |
| 2020-21 | 510 |
| 2021-22 | 480 |
| Total | 1,490 |
Currently, pensions sit outside of the IHT net, allowing individuals to pass on their unused pension funds free of inheritance tax. However, from 2027, unused pension wealth will become part of the taxable estate, meaning it will be liable for IHT at 40% on amounts exceeding the nil-rate band. This major shift is forcing a rethink in estate planning, and for those who can afford to do so, gifts out of surplus income could provide a useful way to mitigate inheritance tax.
How gifts out of surplus income work
Unlike many other gifting strategies, gifts out of surplus income do not require the donor to survive for seven years to escape IHT. Instead, provided the gifts:
- form part of the transferor’s normal expenditure,
- were made out of income,
- left the transferor with enough income for them to maintain their normal standard of living.
The gift is then immediately exempt from IHT. This makes the strategy particularly attractive in light of the upcoming pension changes. Due to pension freedoms, individuals can increase their withdrawals from a defined contribution (DC) pension, using the additional income to fund a tax-free gifting strategy rather than leaving pension wealth exposed to IHT.
Despite its clear advantages, this strategy remains underused, likely due to its complexity and the requirement for detailed record-keeping. Good record-keeping is essential, as HMRC requires clear documentation to prove that gifts were made from surplus income rather than capital and that they did not impact the donor’s standard of living. HMRC demands that those claiming the exemption show:
- Clear evidence that the gifts came from surplus income rather than capital,
- Proof that the donor maintained their usual standard of living while making the gifts, and
- A pattern of regular gifting, rather than one-off lump sums.
Rachael Griffin, tax and financial planning expert at Quilter says:
“With just 1,490 estates making use of this exemption in the past three years, it remains one of the most effective yet underutilised IHT reliefs available. Given the upcoming pension tax changes in 2027, we expect to see a sharp increase in the use of this exemption as more people look for ways to mitigate IHT liabilities.
“For those who can afford to make gifts from surplus income, this is an incredibly valuable strategy, as the relief applies immediately without needing to wait seven years, which is required for most other gifts above the £3,000 annual exemption. However, good record-keeping is absolutely essential. HMRC requires clear documentation proving that gifts were made from surplus income rather than capital, and that they do not reduce the donor’s standard of living. Seeking financial advice can help ensure compliance and maximise the benefits of this overlooked exemption.”
