Following the announcement in the Autumn Budget, that from 6 April 2027, pensions will no longer be exempt from Inheritance Tax (IHT), clients are now looking at other tax efficient ways of passing on their wealth.

Although the removal of the IHT exemption from pensions is yet to be finalised, Darren Austin-Smith, New Quadrant’s Head of Trust Services explores in this Insight how gifts from excess income and combining with discretionary trusts may be an attractive option.

The gifts from excess income exemption allows individuals to make regular gifts from their surplus income without these gifts being subject to Inheritance Tax (IHT). This can be an effective way to reduce the value of an individual’s estate over time, as long as certain criteria are met.

Criteria for the Exemption

To qualify for the gifts from excess income exemption, the following conditions must be met:

1. Surplus Income – The gifts must be made from income and not from capital. Income can include:

• Salary, pension income, or rental income.
• Investment income such as dividends and interest.

2. Normal Expenditure – The gifts must form part of the donor’s regular expenditure. To qualify as ‘normal,’ the payments should be:

• Regular and consistent (e.g., monthly, quarterly, or annually).
• A pattern of gifting that is intended to continue or made with regularity.

Adding Gifts to a Discretionary Trust

3. No Impact on Standard of Living – The gifts must be made from income that is genuinely surplus to the donor’s needs. After making the gifts, the donor should still be able to maintain their usual standard of living without needing to draw on capital.
4. Documentation – Good record-keeping is essential to demonstrate that the gifts meet the above conditions. This may include:

• Evidence of income and expenses.
• Records of the amounts gifted and the dates of payment.
• A written declaration of the intent to make regular gifts.

If an individual does not wish to make outright gifts to beneficiaries, they may choose to contribute their excess income into a discretionary trust. This approach provides more control over how and when the funds are distributed to beneficiaries.

Benefits of Using a Discretionary Trust:

• Flexibility – The settlor can dictate how the funds are distributed and for what purposes.
• Protection – Assets placed in a trust can be protected from beneficiaries’ creditors or from misuse.
• Tax Efficiency – Provided the gifts to the trust meet the conditions for the normal expenditure out of income exemption, they will not be treated as transfers of value for IHT purposes. Also, the future capital growth and income in the trust remains outside of the settlor’s estate.

Criteria for Transferring Excess Income to a Trust:

• The same criteria for surplus income apply when placing the income into a discretionary trust.
• The payments into the trust must be made regularly and should not reduce the donor’s standard of living.
• Documentation should include a trust deed, records of income used to fund the trust, and details of distributions or intended use.

Using a discretionary trust in this way allows individuals to manage their wealth efficiently while reducing potential IHT liabilities, ensuring that their surplus income benefits their chosen beneficiaries at a time that they choose.

 Getting in touch

If you would like to discuss how you might meet the criteria and/or would like  help  to set up and administer trusts for this IHT exemption,  please do get in touch with Darren Austin-Smith,  Head of Trust Services on  darren.austin-smith@nqpltd.com or via 020 7430 7171.