Many people will be aware of the £3,000 annual exemption from Inheritance Tax, (IHT) but few will be aware of or use a further exemption called the normal expenditure out of income exemption. HM Revenue & Customs has recently updated its IHT guidance manual which covers this exemption and for anyone wishing to use the exemption it will be important to keep evidence to support a future claim warns law firm Adams & Remers LLP.

For people with surplus income who want to reduce their inheritance tax liability, making gifts out of their income could be a good solution but there are certain criteria which must be met.

• That it formed part of a settled pattern of giving
• The transferor’s income exceeds expenditure year on year.
• It left the transferor with enough income for them to maintain their normal standard of living.

HMRC does not regard income for this purpose as having the same definition as for income tax purposes. Where people may need to be particularly careful for example is if they have an investment bond or, say, Lifetime Care Plan which have become popular in recent years and whereby the individual makes a single advance payment to the plan provider who then pays the fees for future nursing or residential care. These fee payments will not be seen as income but rather a return of capital and specialist advice should be sought on this to avoid taking out a plan that limits the scope for tax saving.

If you want to make use of the exemption you could consider the following:

• A regular premium life cover policy written under trust e.g to fund for an IHT liability.
• A parent or grandparent funding a stakeholder pension on behalf of their child or grandchild. The value of the gift is further enhanced by a basic rate tax credit when it is paid into the pension plan.
• Paying a grandchild’s school fees.
• And for those on higher incomes, there is scope for making very significant payments into trusts avoiding the normal entry charge where the nil rate band is exceeded”

This is not a straightforward area and you should make sure your IFA or accountant is familiar with these HMRC updates to make sure your estate is not unintentionally liable for a larger than expected IHT bill.