When it comes to inheritance tax (IHT), giving away money or assets can be a minefield. But there’s a handy exemption called ‘gifts out of income’ that could save you and your loved ones from a hefty tax bill. Let’s break it down in simple terms.

What’s the ‘gifts out of income’ exemption?

It’s a way to give away money or assets without worrying about IHT as long as you meet three key conditions:

1. The gifts are regular
2. They come from your income, not your savings or assets
3. You can maintain your standard of living after making the gifts

If you tick all these boxes, the gifts are automatically exempt from IHT – no need to wait seven years like with other types of gifts.

What counts as ‘income’?

This is where it gets tricky. Generally, we’re talking about things like:

1. Your salary
2. Profits from a business
3. Rental income
4. Interest from savings
5. Dividends from investments

But here’s the catch: some things you might think of as income don’t count for this exemption.

What doesn’t count as income?

1. Tax-free payments: Things like Winter Fuel payments or the Christmas Bonus don’t count.
2. Lottery or premium bond winnings: Even if you win regularly, it’s not considered income.
3. Non-taxable redundancy or compensation payments: These are seen as one-off windfalls, not regular income.
4. Withdrawals from life insurance policies: Even if you pay income tax on these, they’re not ‘income’ for this exemption.

Here are a few extra tips:

1. Keep good records: If you’re making regular gifts, document everything. It’ll make life easier for your executors later on.
2. You can use income from previous years: If your income fluctuates, you can potentially use surplus income from the last two tax years.
3. It’s not just cash: You can gift assets, too, but you’ll need to prove you intended to use your income to buy that asset as a gift.

Remember, tax rules can be complicated. If you’re planning to make significant gifts, it’s always worth chatting with a financial advisor or tax professional. They can help you navigate the rules and make sure you’re making the most of this valuable exemption. The bottom line? With careful planning, you can use the ‘gifts out of income’ exemption to help your loved ones financially during your lifetime without worrying about leaving them with an unexpected tax bill later on.