There is an Inheritance Tax exemption that lets you give away unlimited amounts from your income, provided you meet three conditions. It is not a loophole, and it is not new. It has been in the Inheritance Tax Act since 1984. But it is claimed after you die, by whoever fills in your estate’s tax return — usually a spouse or an adult child who has never seen your bank statements.
That is the friction worth understanding. The exemption is not an election you make while you are alive. Nothing is filed when you make the gift. The entire claim rests on evidence that someone else has to reconstruct, often from memory and a shoebox of paperwork. That asymmetry is why families under-claim it, and why the useful work happens now, while you are still the one who knows where the money came from.
What the law actually says
The exemption is set out in section 21 of the Inheritance Tax Act 1984. A transfer of value is exempt if, or to the extent that, it is shown that:
- it was made as part of the transferor’s normal expenditure;
- taking one year with another, it was made out of income; and
- after allowing for all transfers of value forming part of the transferor’s normal expenditure, the transferor was left with sufficient income to maintain their usual standard of living.
Those are the three conditions in IHTA 1984 s.21(1). HMRC’s own manual is blunt about how they operate together: “A gift must meet all of the conditions to qualify for the exemption and must not fall within any of the exceptions” (IHTM14231).
Read those conditions again as a checklist rather than a description. Normal. Out of income. Leaves you able to live as you normally live. Each one is a separate hurdle, and the third is the one that quietly disqualifies gifts that looked generous but were actually funded by spending less on yourself than you needed to.
The form number most people search for is wrong
If you have read about this exemption online, you may have seen it attached to a form called IHT142. No such form is used to claim it. The claim is made on IHT403, “Gifts and other transfers of value”, which is filed alongside the main Inheritance Tax account, IHT400.
The confusion is understandable — HMRC’s numbering is not intuitive, and the exemption sits in a part of the manual numbered IHTM142xx, which may be where the phantom form number comes from. But the practical consequence matters: if you search for the wrong form, you may never find the page that tells you what evidence is needed.
On IHT403, question 6 asks directly: “Are you claiming that gifts should be treated as exempt as ‘gifts out of income’?” If the answer is yes, the executor must complete page 8 of the form. That page is only filled in if box 6 is ticked, and it asks for the deceased’s income and expenditure “for each of the years in which the gifts were made” (IHT403, June 2026 version).
What page 8 actually asks for
Page 8 is a reconstruction of your financial life, year by year. It is not a summary. The income table lists salary, pensions, interest including PEPs and ISAs, investments, rents, annuities (income element) and other, minus Income Tax paid, to arrive at net income. The expenditure table lists mortgages, insurance, household bills, Council Tax, travelling costs, entertainment, holidays, nursing home fees and other. The form then asks for surplus or deficit income for the year — net income minus total expenditure.
If you have ever tried to reconstruct your own spending from three years ago, you can see the problem. Now imagine your spouse doing it for the seven years before your death, without your help, while grieving and dealing with probate.
The form is a guide, not a rigid template. But it tells you what HMRC expects to see: a pattern of income exceeding expenditure, with gifts fitting inside the surplus. If the numbers do not exist, the claim does not either.
What “normal expenditure” means in practice
The phrase “taking one year with another” in the statute is doing real work. It signals that the test is about pattern and capacity over time, not a single year’s arithmetic. A standing monthly payment to an adult child, funded from pension income, is the easy case. A one-off large gift funded by selling a buy-to-let property is the hard case, because the money came from capital, not income.
HMRC’s manual confirms that transfers of capital assets fall outside the exemption “unless, exceptionally, these were purchased from income for the specific purpose of making the gift and they meet the other conditions” (IHTM14231). That exception is narrow. It is not a route for gifting the proceeds of a share sale or an ISA withdrawal.
GOV.UK’s public guidance puts the same point more simply: there is no limit to how much you can give tax free under this exemption, “as long as you can afford the payments after meeting your usual living costs” and “you pay from your regular monthly income” (GOV.UK, Inheritance Tax: gifts). It also notes that birthday or Christmas gifts given from regular income are exempt.
The uncomfortable truth is that the exemption rewards boring consistency. A modest standing payment that has run for years is easier to evidence than a dramatic gift that happened once. If your giving is irregular, the exemption may still apply in principle, but the burden of showing it was normal and funded from income falls on the person completing the form — and they will not have your memory of why that particular transfer happened.
What the exemption does not cover
HMRC’s manual lists the exclusions clearly. The exemption does not apply to transfers on death, to transfers on the termination of a qualifying interest in possession, to deemed potentially exempt transfers under the 1986 Finance Act provisions, or to apportionments under IHTA 1984 s.94. It also does not apply to premiums on a life policy where these are linked to an annuity.
One further point is easy to miss: “Exemption under IHTA84/S21 does not prevent the gift from being taxed under the gift with reservation rules” (IHTM14231). If you give something away but continue to benefit from it — living in a house you have transferred to a child, for example — the normal expenditure exemption does not rescue it. The gift with reservation rules apply separately.
The record-keeping habit that makes the claim survivable
Nothing in the legislation requires you to keep records while you are alive. But the practical reality is that the claim will be made by someone else, and their success depends on evidence you can create now.
The most useful thing you can do is not a tax product or a trust. It is a one-page annual note, kept with your will and your expression of wish form, that records:
- the gifts you made in the tax year, with dates and amounts;
- which income source they came from — pension, salary, rent, interest;
- a simple surplus calculation: income received minus spending on your own living costs;
- a note of any year in which the pattern changed, and why.
This is not a formal document and HMRC has not endorsed any particular format. But it gives the executor something to work from other than guesswork. GOV.UK already advises that “the person who deals with your estate will need to work out what gifts you gave in the 7 years before your death” and that you should keep records of what you gave, to whom, and the value when you gave it (GOV.UK, Inheritance Tax: gifts). The annual surplus note extends that advice to the part that actually decides whether the exemption is claimed.
For couples, there is a second reason to do this. The first death may generate the IHT403. The surviving spouse is often the person least informed about the deceased’s discretionary spending — particularly if one partner handled the finances. A shared annual note is cheap insurance against that asymmetry.
How this fits with the rest of your planning
The normal expenditure exemption is one of five decision moments that shape pre-retirement planning for professionals and couples with substantial assets. It sits alongside the timing of your stop-work date, the funding of the bridge to State Pension age, decumulation and risk psychology, and the family paperwork that quietly decides what happens to the money.
It is worth being clear about what this exemption is not. It is not a substitute for using your annual £3,000 exemption, your small gifts allowance, or your wedding gift allowances. Those are separate and can be combined with normal expenditure giving, except that the small gifts allowance cannot be used on the same person in the same tax year. It is also not a reason to give away money you need. The third condition — sufficient income to maintain your usual standard of living — is there precisely to stop that.
If you are auditing your adviser relationship or reviewing your wider plan, the question to ask is not “how much can I give away?” but “if I died in three years, could my executor prove where this money came from?” That is a different question, and it is the one the form actually asks.
Questions readers ask
Is there a limit on how much I can give under this exemption?
No fixed limit. GOV.UK states there is no limit to how much you can give tax free under normal expenditure out of income, provided you can afford the payments after meeting your usual living costs and you pay from regular monthly income. The constraint is the third statutory condition, not a number.
Can I use this exemption and my £3,000 annual exemption together?
Yes. GOV.UK gives the example of combining a regular payment with the annual exemption in the same tax year. The exception is the small gifts allowance of £250 per person, which cannot be combined with another allowance on the same person.
What if my gifts are irregular?
The statute says “taking one year with another”, which suggests the test looks at pattern over time rather than a single year. But irregular large gifts are harder to evidence as “normal expenditure” than a standing payment. If your giving is irregular, the record-keeping becomes more important, not less.
Does this exemption still work if I give from my ISA?
The exemption requires the gift to be made out of income. ISA withdrawals are capital, not income, even though the ISA itself generates income. HMRC’s manual confirms that transfers of capital assets fall outside the exemption unless they were purchased from income for the specific purpose of making the gift and meet the other conditions — a narrow exception.
What happens if the claim fails?
The gift falls back into the normal Inheritance Tax rules. If it was made within seven years of death, it may be chargeable, with taper relief applying on a sliding scale if the total of gifts exceeds the nil rate band. The estate or the recipient may have to pay. That is why the evidence matters before the claim is made, not after.
Should I tell my family about this now?
Yes, in plain terms. The person who will complete IHT403 needs to know that you make regular gifts, roughly how much, and from which income. You do not need to share every detail of your finances. But a conversation now is more useful than a folder of bank statements discovered later.
If you are reviewing your pre-retirement plan, the question worth asking is not whether this exemption exists — it does — but whether the evidence for it would survive you. That is a records problem, and it is solvable while you are still here to solve it.