Loophole allows you to give money to your children despite inheritance tax

A lesser-known loophole allows you to gift your children more money - without the worry over inheritance tax, but experts have laid out rules you must follow. For example, take a husband-and-wife scenario with a combined £1M inheritance tax threshold, including savings and investments and property as well as their pensions.

If they wanted to give their (adult) children all these benefits upon death, they'd be taxed up to 40% on any future inheritance, however, they can adhere to the small annual gifting allowance instead. But, there is an exemption on gifts above this, also avoiding the seven-year rule, as long as they are made out of surplus income. The couple, with shared finances, want to opt for gifting out surplus income to their grown-up children.

In a letter to the MailOnline's This is Money expert Harvey Dorset, the husband-and -wife explained that they have shared finances, with 'no allocation of income or expenditure to each of us'.

They asked reporter and money expert Harvey Dorset: "In these circumstances how can we handle this? HMRC's form IHT403 can presumably only be completed and used for an individual, not for a couple?"

The couple wanted to find out how they can go about this - and to ensure it is 'all above board' - they were looking for financial advice on the matter.

The gifting out of surplus income which allows 'money given away to become free of inheritance tax' is becoming increasingly favoured for people in this kind of financial scenario.

Harvey Dorset reporting for This is Money advised: "Gifting out of surplus income is becoming increasingly popular with those looking to cut the eventual inheritance tax bill on their estate.

"More estates are set to be pulled into the inheritance tax net in coming years, with the tax-free thresholds frozen until 2030 and pension pots due to be included from April 2027."

Harvey explained that more people 'will need to take action to mitigate the eventual tax bill' as financial advisers say they've been experiencing 'a rush of questions' as families try to figure out what they can do.

And gifts out of surplus income have become extremely popular as a lesser-known way to be exempt from inheritance taxes.

A Freedom of Information Act request to HMRC obtained figures on the subject, it shows the amount transferred under the gifts out of surplus income loophole jumped to £144million in 2023 - 2024 - up from £52million in 2022 - 2023.

A standard annual inheritance tax-free gifting allowance amounts to £3,000 per year for an individual person - however 'unlimited gifts of up to £250' can also be made, but 'only one of these can be made to each person' Harvey of the MailOnline explained.

Aside from this, 'any amount can be gifted but you must survive for seven years for it to be free of inheritance tax', says Harvey.

If you were to pass away before that seven years was up then 'inheritance tax is charged on a sliding scale' he added.

Harvey explained more in the MailOnline: "Gifting out of surplus income, officially known as 'normal expenditure out of income', allows money given away to immediately become free of inheritance tax and not be subject to the seven-year rule.

"This, however, is only the case if the money is gifted within the rules of the exemption and you must keep very good records."

Financial advisers agree that if 'gifts made meet the rules' they can be separated from the inheritance tax calculation - and sometimes this is even the case if the gifter dies before seven years passes.

Gifts 'must be made from income on a regular basis as part of your normal expenditure' reports MailOnline - and gifters must be left with enough income for them to continue to meet their own normal living expenses.- without reverting to any capital funds.

Income includes earnings - after the deduction of taxes along with pensions, rent collected, interest and dividends, a financial advisor will be able to take you through all the details.

HMRC considers normal expenditure to be 'regular gifting from income' and will look at how often gifting occurred - and the pattern of amounts given.

You'll also need to keep records because the exemption isn't claimed until after death, the HMRC IHT403 form has a page where you must record all of this information in advance

A couple will need to complete one form each, with an allocated amount of the joint expenditure recorded.

Zoe Brett, financial planner at EQ Investors, told the MailOnline: "Dealing with any estate can be administratively burdensome but with a little forward planning you can take much of the stress away from your loved ones when the time comes.

"Where the deceased and their partner made joint gifts from joint assets the HMRC will typically assume a 50/50 split between them.

"In terms of completing the IHT403, you only report the deceased share, not the total amount of the gift.

"Be sure to retain ample evidence of transactions, both income and gifts - evidence would be things like bank statements and written records of the gifts made and to whom."

HMRC's Form IHT403, which is completed upon death needs to be filled out separately for each person in a couple

There are three key conditions that must be met:

• The gift must be part of the donor's normal expenditure
• It must be made out of income, not capital
• After making the gift, the donor must retain enough income to maintain their usual standard of living

You can find out more and view the IHT403 form here on HMRC