The 2024 Autumn Budget confirmed that, from 6 April 2027, pensions will fall within the scope of Inheritance Tax (IHT). This shift has renewed focus on how pensions can feature effectively in estate planning.
Normal Expenditure Out of Income Exemption Explained
Under Section 21 of the Inheritance Tax Act 1984 (IHTA 1984), certain lifetime gifts can be exempt from IHT if they satisfy specific conditions. This exemption can be useful for individuals wishing to transfer wealth during their lifetime without creating a tax charge, provided the gifts are made from income rather than capital.
Reducing an Estate Through Regular Gifting
For individuals, this exemption presents an opportunity to reduce their taxable estate through regular gifting from income. However, maintaining clear records and being consistent are essential to support any claim and satisfy HMRC requirements.
Conditions for IHT Exempt Lifetime Gifts
To qualify, the gift must:
- Form part of the donor’s normal expenditure,
- Be made from income, assessed over time, and
- Leave the donor able to maintain their usual standard of living.
“Normal” refers to gifts that are habitual or intended to become so. Even a first gift may qualify if there is clear evidence of an intention to make similar gifts in the future.
The ‘income’ gifted must be net of income tax and assessed in line with accounting principles. Variations in yearly income do not prevent exemption, provided the donor can show that the gift could have been made from income after meeting living expenses.
Pension Income Gifting and IHT Planning
When it comes to pensions, pension income received from a drawdown plan or from an annuity should qualify for this exemption if the same conditions are met. These gifts can therefore help reduce the taxable value of an estate.
It is important, however, to distinguish income from capital. Regular pension income may qualify, whereas lump sum withdrawals generally do not. The position of the Pension Commencement Lump Sum (PCLS) is uncertain, as HMRC has not confirmed whether it is treated as income for these purposes. Care should therefore be taken when using PCLS for IHT planning in this scenario.
Evidence and Record Keeping Requirements
HMRC typically seeks evidence of a gifting pattern over three or four years, although a single gift may qualify if there is documented intent to continue. This creates planning opportunities for those wishing to pass on pension income efficiently during retirement.
As pensions come within the scope of IHT, the “normal expenditure out of income” exemption could become an increasingly valuable strategy. Clients should ensure all gifts are properly documented, affordable, and supported by evidence of regularity to withstand potential HMRC inquiry.
If you have any questions or would like to discuss this further, please contact our MWM team
Disclaimer
The information provided is for general information only and is not intended to address the particular requirements of an individual or business. It does not constitute any form of advice or recommendation by Menzies Wealth Management Ltd and should not be relied upon by individuals in either making or refraining from making any financial decisions. Where necessary, you should seek appropriate professional advice before acting on any of the information provided.
Past performance is not necessarily a guide to future performance. The value of investments and the income derived from them can go down as well as up. Investors may not get back the amount they invested.
Menzies Wealth Management is authorised and regulated by the Financial Conduct Authority (486548). Registered address: 4th Floor, 95 Gresham Street London EC2V 7AB Registered in England and Wales 06597008.
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