Sep 16, 2026 · 24 min
Surplus-income gifts offer a route around inheritance tax
How to Turn Income Into an Inheritance Tax Break
Planned pension-tax changes could increase the value of estates, making regular gifts from genuinely surplus income more consequential.
- 1Regular gifts from surplus income can reduce an estate without relying solely on the seven-year rule.
- 2The exemption depends on maintaining a normal lifestyle, using qualifying income and keeping detailed records.
- 3Turning capital into income is possible but introduces tax, pension and professional-advice complications.
Don't miss
Sarah Colts draws the line between a straightforward surplus-income gifting plan and more complex attempts to manufacture income from capital.
The brief
With more pension assets potentially entering inheritance-tax calculations from April 2027, Sarah Colts explains why surplus-income gifting deserves attention.
The key distinction is between capital and income: regular gifts can qualify when they come from genuine surplus income and do not reduce the donor’s normal standard of living.
School fees, nursery costs and recurring presents may fit the rules, but HMRC can examine spending patterns, lifestyle changes and whether gifts were genuinely regular.
The practical discipline is record-keeping: donors may need to document each gift and preserve evidence for the relevant seven-year period.
Creating income from capital through savings, investments or an annuity may broaden the strategy, but tax treatment, pension uncertainty and grey areas make professional advice important.
What was said on this episode
16 statements · 8 positive · 5 negative · 1 mixed · 2 neutral
More pension pots will become eligible for UK inheritance tax in April 2027.
“Next year, in April 2027, the IH2 rules will be changing again, and more pension pots will become... eligible for inheritance tax.”
Listen at 2:21
Pension changes can make estates larger for inheritance tax and produce higher tax bills.
“Whereas now that completely changes. It's not just you've got to think about which thing to spend first, but also your estates can be much bigger in terms of inheritance tax and there could be a much higher tax bill.”
Listen at 3:24
Qualifying surplus-income gifts can be unlimited and excluded from the estate for inheritance tax.
“But you can give away as much as you like to as many different people as you like, and it falls out of your estate for inheritance tax purposes.”
Listen at 5:09
Surplus-income gifts must come from qualifying income such as wages, pensions, or investments.
“It's got to be things like pension income or wages. It's got all sort of investment income.”
Listen at 5:55
Surplus-income gifts must be made in a regular pattern to qualify.
“And the other rule is that you've got to give it away in a regular pattern.”
Listen at 6:03
A dramatic spending reduction may mean surplus-income gifts breach the standard-of-living condition.
“And if you're going to cut back on that dramatically, then that's going to count as having eaten into your standard of living.”
Listen at 7:59
Detailed records of surplus-income gifts, dates, recipients, sources, income, and expenditure are needed.
“you really need to make a record of that. So you've got things like the gift, the date you made it, who it's to, where the money's coming from, and that sort of annual income and expenditure stuff.”
Listen at 8:46
HMRC provides a template for maintaining surplus-income gift records.
“I would go onto the HMR website and they will show you a template of how to keep those records.”
Listen at 9:21
UK equity-income funds may provide dividends of around 5%.
“you could get, you know, dividends of around 5%.”
Listen at 14:20
A purchased life annuity's return-of-capital portion can be tax-free.
“that portion of the income that you get is tax-free”
Listen at 16:12
The return-of-capital portion of a purchased life annuity cannot be given away under the rule.
“the bit that is considered to be the return of capital, you can't give that away.”
Listen at 17:50
Restructuring assets to generate income is allowed for this inheritance-tax rule.
“That is totally allowed because they're not interested in how you use your assets for this particular joy of IHT.”
Listen at 18:48
Giving away pension tax-free cash as surplus income is generally difficult to establish.
“you can't just give away your tax-free cash you would find it quite difficult to just take the tax-free cash from your pension, leave the rest of your pension in place and give the tax-free cash away and say, yeah, that's income.”
Listen at 19:28
Some circumstances permit living from capital while giving away income as surplus income.
“there will be circumstances under which you can dip into some of your own capital in order to live off it and give away your income.”
Listen at 20:58
Expert advice is worthwhile for ambiguous surplus-income gifting arrangements.
“It really is worth talking to an expert because they can sort of, they know all the case law and they know, you know, the decisions that have been made in the past.”
Listen at 21:52
People should obtain advice before attempting complex inheritance-tax gifting strategies.
“I would definitely get some advice.”
Listen at 22:02
Statements are attributed to the speaker as said on the episode and reflect their view at the time, not PodLume's. They are not advice.