For the year to March 2025, HMRC collected £8.2 billion in Inheritance Tax (IHT). This was almost 11% more than the year before. From 2027, pensions are likely to also be part of what’s taxed for IHT; this means the amount collected will go up a lot.

Because of this, more people are reviewing their estates and previous plans. One option people are especially interested in is the ‘normal expenditure out of income’ (NEOOI) gifting rule. This is mainly because they worry about pensions becoming subject to IHT. Some people had planned to pass on their pension money, not just use it for income for themselves.

This rule has clear advantages. Firstly, the gift is immediately outside your estate; there’s no seven-year waiting period. Secondly, you can give away as much as your extra income allows.

But there are also downsides. You can usually only claim this exemption after someone dies. This means you won’t know for sure if the gift qualified until then.

For the rule to work, gifts must:

• Be part of a person’s normal spending.
• Come from their income.
• Leave the person with enough income to keep their usual lifestyle.

These rules are not always clear. There’s no guarantee any gifts will qualify. So, it’s often safer to be careful rather than try to stretch HMRC’s rules. This article looks at the most common questions about this rule.

Normal Spending

1. When is a gift ‘normal’ spending?

They must be part of a regular pattern of giving. You show this by looking at your past gifts. HMRC usually checks your giving history for about three or four years to see a regular pattern. Sometimes, they accept a shorter time. This happens if your executors can provide evidence that you planned to keep giving gifts, like paying life insurance or setting up a regular payment.

2. Do gifts have to go to the same person?

No, gifts don’t have to go to the exact same person every year. The rule should still work if you give to the same type of person. For example, all your children or all your grandchildren. Or, you could give to a special trust (a ‘discretionary trust’). The people who manage the trust (the trustees) will then decide which of the possible family members gets the money.

3. Do gifts have to be for the same amounts?

Usually, your gifts should be about the same size. This means they could be the exact same amount each year; or they could be the same percentage of your extra income. You might also give gifts where the amount changes for a specific reason; for example, paying school fees for grandchildren.

If the amounts are not the same, the pattern isn’t always broken. But if one gift is much bigger than your other regular gifts, HMRC might not accept some or all of it.

For instance, say you usually give £10,000 each year, but one year, you give £100,000. HMRC might accept £10,000 as normal spending (if it matches your usual £10,000 pattern); the extra £90,000 might then be seen as a ‘Potentially Exempt Transfer’ (PET) from that date. If however, it’s clear the big gift was for a different reason than your other gifts, HMRC might not accept any of it as a NEOORI.

4. Do gifts have to be given at the same times?

No, there are no strict rules on how often you give gifts to show a regular pattern. You could give gifts monthly, every three months, every six months, or yearly. You could even start giving monthly, then switch to yearly. This is fine, as long as the yearly amounts are still similar and you give to the same group of people. Giving gifts every two years might also be okay, but it will take longer to show a regular pattern this way.

Income

5. What counts as income?

You must usually make gifts from your net income earned in the current tax year. This is the money you can spend after income tax, but the income for this rule is not the same as income for tax purposes. Gifts must not come from your capital (savings or assets).

Generally, this income includes money you get after tax from jobs or pensions. It also includes the regular money your investments make, like interest or dividends. Rental income counts too. If you have an ISA and actually take out the income (instead of leaving it in), that counts as well.

If you have a ‘purchased life annuity’, you get regular payments; however, these are usually part interest and part return of your original money. Only the interest part can count as income for this rule.

6. Can tax-free pension money count as income?

Yes, money you take from your pension (called ‘pension drawdown’), including the tax-free lump sum, can count as income for this rule. But these payments must still meet all the other rules. For example, if you take out all your tax-free cash quickly and give it away over just one or two years, it usually won’t count; these payments wouldn’t seem like regular income. However, if you spread out these withdrawals over a longer time, like you would with an annuity, it’s more likely to qualify.

7. Do Investment Bond withdrawals count as income?

No. When you take money from an investment bond, it’s usually seen as getting back your own capital. This is true even if you have to pay income tax on it. Also, money you get from a ‘discounted gift trust’ or a ‘loan trust’ does not count as income.

8. Can saved income count?

Generally, if you put income back into other investments, it becomes ‘capital’ (like savings). This includes income that automatically reinvests if you own ‘accumulation’ units. It doesn’t matter if you paid tax on this saved income when you got it.

Usually, ‘income’ means money you got in the current tax year. But you can use income from a past year if it hasn’t turned into capital. For example, income kept in your bank account. However, HMRC usually considers money in a bank account to be capital if it’s been there for more than two years.

9. Can couples combine their income for gifts?

In the UK, each person is taxed separately. So, if you and your partner make gifts together, HMRC looks at each of you separately. They work out each person’s extra income on their own. You can’t just use your total household income.

If one partner earns a lot more, HMRC won’t usually let them transfer income to the lower earner to boost their extra income, for this rule.

If the higher earner pays for the lower earner’s costs, this could be seen as a regular expense for the higher earner. This would lower their own extra income. So, they could gift less under the rule.

It might be better for each partner to make separate gifts instead of joint ones. This could enable the higher earner to give larger regular gifts, as they will likely have more extra income.

Usual Lifestyle

10. What is ‘extra income’?

You must make gifts from your extra income. This is simply the money left over each year after you’ve paid for your usual spending. Giving a gift from truly extra income should not change how you live your life.

If you have to use your savings (capital) to keep up your lifestyle, it shows you don’t have enough extra income to cover the gift. If this happens, you might lose the rule’s benefit, or it might be limited. So, first work out your income, then list your normal living costs. The money left is your extra income.

11. What counts as normal living costs?

These are your everyday costs. For example, housing (mortgage, rent), bills (heating, electricity, council tax), and insurance. They also include other costs that keep up your lifestyle, like travel, regular holidays, and club fees.

HMRC form IHT403 has a list of main expenses to consider, but it’s not a full list. If you have a big one-off cost, you might argue it’s not ‘normal’; so, it wouldn’t count as an expense and wouldn’t reduce your extra income. Examples include major home repairs like a new kitchen.

Buying a new car every 10 years might also not count; but costs for a leased car or one bought with monthly payments usually count as normal living costs. There are no guarantees, and it depends on your unique situation.

12. Can couples split household costs?

Yes, just like income, one partner might spend more than the other. But household costs like council tax and heating bills are usually seen as shared equally. Even if the higher earner pays these bills, HMRC will still likely split the cost equally for this rule. Other costs that clearly belong to one partner don’t have to be split: for example, costs for a hobby or a gym membership.

13. What is ‘usual lifestyle’?

This means different things for different people. Your ‘usual lifestyle’ is generally how you live when you make the gift, but if something unexpected happens that changes your lifestyle (like losing your job), you might not lose the rule’s benefit. This is true even if you have to use your savings for a short time to keep giving gifts.

Claiming the Rule

14. Do I need to tell HMRC about the gifts?

No, you don’t have to tell HMRC about these gifts when you make them. This exemption is claimed after the person who gave the gifts has died. The arrangements that the deceased made could then be rejected by HMRC.

There’s one exception: regular gifts into a ‘discretionary trust’. You must report these if, without this rule, the gift would cause a 20% tax charge. So, you’ll need to fill in form IHT100 if these gifts, plus any other taxable gifts made in the last seven years, are more than the ‘nil rate band’ (the tax-free allowance).

HMRC will then tell you if they accept your claim for the NEOOI rule. If they accept it, you won’t pay tax on the regular gifts.; but if they reject it, you might have to pay tax right away.

15. How do I claim the rule?

The people managing the deceased’s estate (the executors) usually claim this rule after death. They will need to send detailed records of all gifts made, and full income and spending details for the seven years prior to death. They use form IHT403 for this.

It’s very important that the person making the gifts keeps good records while they are alive. This helps the executors make a successful claim. It can be hard for executors to gather seven years of income, spending, and gift details later on. Good record keeping is key to good planning.

Summary

If you try to stretch the rules for what counts as income and spending to get more ‘extra income’, HMRC might reject your claim; they could reject all or part of it. If any part of your claim is turned down, it will be treated as a ‘failed Potentially Exempt Transfer’ (PET). This could use up the tax-free allowance for the estate, or tax could be payable on the gift posthumously. It might also use up the tax-free allowance for any trusts set up after the gift was made and affect the tax paid on the 10-year anniversaries of trusts.

From the above, you will see there are lots of areas to consider. But importantly, it shows there could also be lots of opportunities for those with the right circumstances.

This article is intended as an information piece and is based on Henwood Court’s understanding of the current legislation and should not be construed as advice.