IHT and regular gifts out of income.
Discussion
OK, we know the principle. However, what is "income"?
Very obviously, someone with a big PAYE salary or receiving hefty dividends may have surplus income.
But what if someone has a big S&S ISA but no direct earnings, dividends or pension income. They live on withdrawals from the ISA.
Is their "income" only such income as arises within the ISA from year to year?
Does that income have to be withdrawn to count as "income"?
Or is every increase in overall ISA value classed as "income"?
Or is every withdrawal from SA automatically classed as income?
Very obviously, someone with a big PAYE salary or receiving hefty dividends may have surplus income.
But what if someone has a big S&S ISA but no direct earnings, dividends or pension income. They live on withdrawals from the ISA.
Is their "income" only such income as arises within the ISA from year to year?
Does that income have to be withdrawn to count as "income"?
Or is every increase in overall ISA value classed as "income"?
Or is every withdrawal from SA automatically classed as income?
Panamax said:
OK, we know the principle. However, what is "income"?
Very obviously, someone with a big PAYE salary or receiving hefty dividends may have surplus income.
But what if someone has a big S&S ISA but no direct earnings, dividends or pension income. They live on withdrawals from the ISA.
Is their "income" only such income as arises within the ISA from year to year?
Does that income have to be withdrawn to count as "income"?
Or is every increase in overall ISA value classed as "income"?
Or is every withdrawal from SA automatically classed as income?
Look at IHT form 403. See section 20. This indicates the sources of income, and expenditure, and therefore surplus income, for each of the past 7 tax years, which information is needed by your executors for the purposes of them claiming that regular gifts you have made have indeed been made out of surplus income. This should answer your question.Very obviously, someone with a big PAYE salary or receiving hefty dividends may have surplus income.
But what if someone has a big S&S ISA but no direct earnings, dividends or pension income. They live on withdrawals from the ISA.
Is their "income" only such income as arises within the ISA from year to year?
Does that income have to be withdrawn to count as "income"?
Or is every increase in overall ISA value classed as "income"?
Or is every withdrawal from SA automatically classed as income?
R.
Panamax said:
OK, we know the principle. However, what is "income"?
Very obviously, someone with a big PAYE salary or receiving hefty dividends may have surplus income.
But what if someone has a big S&S ISA but no direct earnings, dividends or pension income. They live on withdrawals from the ISA.
Is their "income" only such income as arises within the ISA from year to year?
Does that income have to be withdrawn to count as "income"?
Or is every increase in overall ISA value classed as "income"?
Or is every withdrawal from SA automatically classed as income?
Very unlikely if not impossible to be considered income because you are drawing down capital not income. I considered this but a bit of research suggested it’s not a good idea. Gift and live 7 years is the only option. Very obviously, someone with a big PAYE salary or receiving hefty dividends may have surplus income.
But what if someone has a big S&S ISA but no direct earnings, dividends or pension income. They live on withdrawals from the ISA.
Is their "income" only such income as arises within the ISA from year to year?
Does that income have to be withdrawn to count as "income"?
Or is every increase in overall ISA value classed as "income"?
Or is every withdrawal from SA automatically classed as income?
Good video from an IFA just published the other day: https://youtu.be/BtcNCd1sTw0?si=_tUKrDL1oPjxGBYp
It sounds like only dividends and interest from the ISA that are extracted into a bank account will qualify.
It sounds like only dividends and interest from the ISA that are extracted into a bank account will qualify.
LeoSayer said:
Good video from an IFA just published the other day: https://youtu.be/BtcNCd1sTw0?si=_tUKrDL1oPjxGBYp
It sounds like only dividends and interest from the ISA that are extracted into a bank account will qualify.
Yep, makes sense really to only consider 'natural yield' distributions paid out to a bank account as income rather than selling down assets to manufacture income. It sounds like only dividends and interest from the ISA that are extracted into a bank account will qualify.
S21 of Inheritance Tax Act 1984 is what governs it
Act said:
21 Normal expenditure out of income.
(1)A transfer of value is an exempt transfer if, or to the extent that, it is shown—
(a)that it was made as part of the normal expenditure of the transferor, and
(b)that (taking one year with another) it was made out of his income, and
(c)that, after allowing for all transfers of value forming part of his normal expenditure, the transferor was left with sufficient income to maintain his usual standard of living.
(2)A payment of a premium on a policy of insurance on the transferor’s life, or a gift of money or money’s worth applied, directly or indirectly, in payment of such a premium, shall not for the purposes of this section be regarded as part of his normal expenditure if, when the insurance was made or at any earlier or later time, an annuity was purchased on his life, unless it is shown that—
(a)the purchase of the annuity, and
(b)the making or any variation of the insurance or of any prior insurance for which the first-mentioned insurance was directly or indirectly substituted,
were not associated operations.
(3)So much of a purchased life annuity (within the meaning of [F1section 423 of the Income Tax (Trading and Other Income) Act 2005] as is, [F2exempt from income tax under section 717 of that Act] , shall not be regarded as part of the transferor’s income for the purposes of this section.
(4)Subsection (3) above shall not apply to annuities purchased before 13th November 1974.
(5)Section 3(4) above shall not apply for the purposes of this section.
The bit that always concerns me the most, and what I'll be taking advice on at some point if I end up trying to get rid of as much as possible, is 21(1)(c) and the provision that the "the transferor was left with sufficient income to maintain his usual standard of living." I can see that being problematic if one plans to enjoy a lifestyle based on a combination of fresh income and other assets.(1)A transfer of value is an exempt transfer if, or to the extent that, it is shown—
(a)that it was made as part of the normal expenditure of the transferor, and
(b)that (taking one year with another) it was made out of his income, and
(c)that, after allowing for all transfers of value forming part of his normal expenditure, the transferor was left with sufficient income to maintain his usual standard of living.
(2)A payment of a premium on a policy of insurance on the transferor’s life, or a gift of money or money’s worth applied, directly or indirectly, in payment of such a premium, shall not for the purposes of this section be regarded as part of his normal expenditure if, when the insurance was made or at any earlier or later time, an annuity was purchased on his life, unless it is shown that—
(a)the purchase of the annuity, and
(b)the making or any variation of the insurance or of any prior insurance for which the first-mentioned insurance was directly or indirectly substituted,
were not associated operations.
(3)So much of a purchased life annuity (within the meaning of [F1section 423 of the Income Tax (Trading and Other Income) Act 2005] as is, [F2exempt from income tax under section 717 of that Act] , shall not be regarded as part of the transferor’s income for the purposes of this section.
(4)Subsection (3) above shall not apply to annuities purchased before 13th November 1974.
(5)Section 3(4) above shall not apply for the purposes of this section.
WayOutWest said:
LeoSayer said:
Good video from an IFA just published the other day: https://youtu.be/BtcNCd1sTw0?si=_tUKrDL1oPjxGBYp
It sounds like only dividends and interest from the ISA that are extracted into a bank account will qualify.
Yep, makes sense really to only consider 'natural yield' distributions paid out to a bank account as income rather than selling down assets to manufacture income. It sounds like only dividends and interest from the ISA that are extracted into a bank account will qualify.
If the monies from the S&S ISA were exclusively generated by dividends, then that'd be classed as income. But if you were selling off holdings to generate the funds, then that'd be classed as coming from capital.
On that basis, you'd have to be very sure that the dividend income alone is going to be consistent both in terms of frequency and amount. That's because in order to have any chance of your executors getting an IHT exemption, the gifts must have formed part of the transferor's normal expenditure.
Therefore HMRC would want to see a regular pattern of gifting over a period of time. They say "a reasonable span would normally be three to four years" (but exceptions are possible).
This goes into more detail: https://www.gov.uk/hmrc-internal-manuals/inheritan...
On that basis, you'd have to be very sure that the dividend income alone is going to be consistent both in terms of frequency and amount. That's because in order to have any chance of your executors getting an IHT exemption, the gifts must have formed part of the transferor's normal expenditure.
Therefore HMRC would want to see a regular pattern of gifting over a period of time. They say "a reasonable span would normally be three to four years" (but exceptions are possible).
This goes into more detail: https://www.gov.uk/hmrc-internal-manuals/inheritan...
I will probably have this from both ends
My parents have been gifting £3k a year from surplus income. I have no idea where it comes from but they had state pension, police pension and a private pension he built up between retiring from the police in the early 80s and winding up hid driving school in the late 1990s. I don t know if he bought an annuity or is using drawdown but as his executor at some stage I will need to find out. Mum died in July and the gifts were declared then and HMRC didn t (maybe haven t yet) come knocking.
On the other end I am looking at gifting to my children with the changes to pension pots coming in, I presume that if I drawdown say £20k a year it is seen as income (even if it involves selling assets held in the pension pot) and gifting £3k of that would be exempt as surplus income. As long as I can still pay the bills, tax and insure the car, feed the wife and I etc..
Now what if the £3k I gift to my children is the same £3k my father gifts to me? Is my gift classed as surplus income? Dad is late 90s and I am late 60s.
My parents have been gifting £3k a year from surplus income. I have no idea where it comes from but they had state pension, police pension and a private pension he built up between retiring from the police in the early 80s and winding up hid driving school in the late 1990s. I don t know if he bought an annuity or is using drawdown but as his executor at some stage I will need to find out. Mum died in July and the gifts were declared then and HMRC didn t (maybe haven t yet) come knocking.
On the other end I am looking at gifting to my children with the changes to pension pots coming in, I presume that if I drawdown say £20k a year it is seen as income (even if it involves selling assets held in the pension pot) and gifting £3k of that would be exempt as surplus income. As long as I can still pay the bills, tax and insure the car, feed the wife and I etc..
Now what if the £3k I gift to my children is the same £3k my father gifts to me? Is my gift classed as surplus income? Dad is late 90s and I am late 60s.
Panamax said:
This theme is rather what I expected. It seems there's little opportunity for an ISA compound growth investor to make "regular gifts from surplus income", however well things are going.
One could consider swapping into income generating shares/assets or trying to gift as much whilst in gainful employment? Admittedly you'd probably sacrifice further growth, but that may be an acceptable trade-off if it saves a significant amount of IHT?I saw in one of the papers recently that the Badenoch is talking about IHT abolition if the Conservatives win the next election...
Panamax said:
This theme is rather what I expected. It seems there's little opportunity for an ISA compound growth investor to make "regular gifts from surplus income", however well things are going.
…….
It does seem a bit odd that you can use funds drawn from capital in a SIPP but not from an ISA.…….
I wonder why there’s that discrimination? I can’t think of any obvious reason.
If wife and I wanted to go down the gifts from surplus income route then it’s potentially an issue for us as we take money monthly from our combined ISAs as part of our income in retirement. Our SIPPs and ISAs are about the same size.
Touch wood, so far it’s been covered by gains overall but that won’t always be the case - even now if you looked on a month by month basis there will be months where it’s lost money.
LooneyTunes said:
Panamax said:
This theme is rather what I expected. It seems there's little opportunity for an ISA compound growth investor to make "regular gifts from surplus income", however well things are going.
One could consider swapping into income generating shares/assets or trying to gift as much whilst in gainful employment? Admittedly you'd probably sacrifice further growth, but that may be an acceptable trade-off if it saves a significant amount of IHT?I saw in one of the papers recently that the Badenoch is talking about IHT abolition if the Conservatives win the next election...
Might leave a dent in Government finances, mind…..
Yup, give it, document it, & live 7+ years seems to be the best solution.
Sheepshanks said:
It does seem a bit odd that you can use funds drawn from capital in a SIPP but not from an ISA.
I wonder why there s that discrimination? I can t think of any obvious reason.
If wife and I wanted to go down the gifts from surplus income route then it s potentially an issue for us as we take money monthly from our combined ISAs as part of our income in retirement. Our SIPPs and ISAs are about the same size.
Touch wood, so far it s been covered by gains overall but that won t always be the case - even now if you looked on a month by month basis there will be months where it s lost money.
It’s not odd, drawdown from a pension fund is designated as income and withdrawals from an ISA is not. That’s the law, simple as that. I wonder why there s that discrimination? I can t think of any obvious reason.
If wife and I wanted to go down the gifts from surplus income route then it s potentially an issue for us as we take money monthly from our combined ISAs as part of our income in retirement. Our SIPPs and ISAs are about the same size.
Touch wood, so far it s been covered by gains overall but that won t always be the case - even now if you looked on a month by month basis there will be months where it s lost money.
Interesting when you put this into Google AI:
Gifts made from your regular surplus income are immediately exempt from UK inheritance tax (IHT) with no upper monetary limit and no 7-year waiting period.
The Three Core HMRC Tests:
To qualify for the "normal expenditure out of income" exemption under Section 21 of the Inheritance Tax Act 1984, your arrangement must satisfy three strict tests:
The Income Test: Funded strictly from net, after-tax income (e.g., pensions, salary, dividends, rental income) rather than core capital or savings.
The Pattern Test: Must form part of a regular, habitual pattern of giving (monthly standing orders or recurring annual Christmas/birthday gifts).
The Lifestyle Test: Must leave you with enough residual income to maintain your exact normal standard of living without dipping into capital.
Simulated Gifting Example:
Net Annual Income: £45,000 (pensions and investments)
Normal Living Expenses: £30,000 (housing, utilities, food, leisure)
True Surplus Income: £15,000 available to gift annually
Action: Setting up a £1,250 monthly transfer to a child's account leaves your lifestyle intact and creates an immediately IHT-free transfer.
Critical Pitfalls & Hidden Traps:
Accumulated Cash: Leaving income untouched in an ISA or bank account for too long (typically over two years) causes HMRC to reclassify it as capital.
Lump Sum Extractions: Selling investments or taking massive, ad-hoc pension lump sums to fund gifts invalidates the income qualification.
After-Death Scrutiny: Because this is usually claimed by your executors via Schedule IHT403 after you pass away, failing to keep meticulous records causes HMRC to disallow the claim.
Essential Record Keeping:
Maintain a written annual spreadsheet tracking total net income and itemised living costs.
Keep a dedicated gifting bank account or clearly labelled standing orders showing the chronological flow from income source to recipient.
Draft a simple signed memorandum stating your intent to make regular gifts out of surplus income
Gifts made from your regular surplus income are immediately exempt from UK inheritance tax (IHT) with no upper monetary limit and no 7-year waiting period.
The Three Core HMRC Tests:
To qualify for the "normal expenditure out of income" exemption under Section 21 of the Inheritance Tax Act 1984, your arrangement must satisfy three strict tests:
The Income Test: Funded strictly from net, after-tax income (e.g., pensions, salary, dividends, rental income) rather than core capital or savings.
The Pattern Test: Must form part of a regular, habitual pattern of giving (monthly standing orders or recurring annual Christmas/birthday gifts).
The Lifestyle Test: Must leave you with enough residual income to maintain your exact normal standard of living without dipping into capital.
Simulated Gifting Example:
Net Annual Income: £45,000 (pensions and investments)
Normal Living Expenses: £30,000 (housing, utilities, food, leisure)
True Surplus Income: £15,000 available to gift annually
Action: Setting up a £1,250 monthly transfer to a child's account leaves your lifestyle intact and creates an immediately IHT-free transfer.
Critical Pitfalls & Hidden Traps:
Accumulated Cash: Leaving income untouched in an ISA or bank account for too long (typically over two years) causes HMRC to reclassify it as capital.
Lump Sum Extractions: Selling investments or taking massive, ad-hoc pension lump sums to fund gifts invalidates the income qualification.
After-Death Scrutiny: Because this is usually claimed by your executors via Schedule IHT403 after you pass away, failing to keep meticulous records causes HMRC to disallow the claim.
Essential Record Keeping:
Maintain a written annual spreadsheet tracking total net income and itemised living costs.
Keep a dedicated gifting bank account or clearly labelled standing orders showing the chronological flow from income source to recipient.
Draft a simple signed memorandum stating your intent to make regular gifts out of surplus income
Armitage.Shanks said:
The Income Test: Funded strictly from net, after-tax income (e.g., pensions, salary, dividends, rental income) rather than core capital or savings.
^^ This is the whole question - what is after-tax income? The obvious meaning is net income after tax as opposed to gross income. But in the context of ISA there were two further questions,The big one - if income drawn from an ISA is tax free, can it ever be "post tax"?, and
The other one - is it sufficient for income to arise in the ISA or does it need to be withdrawn?
I think this thread has led to the answers,
Yes, and
Needs to be withdrawn so that it's spendable.
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