Less than 2% of estates paying inheritance tax (IHT) have used the gifts out of surplus income gifting rule in the last three years, new analysis from Quilter has shown.

A freedom of information request to HMRC by the wealth manager and financial adviser found that 1,490 estates have made use of the rule in the last three years, the time for which data is available.

However, Quilter said the figure is expected to increase significantly due to changes to upcoming proposals bringing pension death benefits within the IHT net.

With IHT receipts recently reaching a new annual record high of £8.2bn in the latest tax year, in addition to the Government’s planned changes to the tax treatment of pensions due from April 2027, Quilter suggested this strategy is currently “underutilised”.

Tax and financial planning expert at Quilter, Rachael Griffin, said: “With just 1,490 estates making use of this exemption in the past three years, it remains one of the most effective yet underutilised IHT reliefs available.

“Given the upcoming pension tax changes in 2027, we expect to see a sharp increase in the use of this exemption as more people look for ways to mitigate IHT liabilities.”

Currently, pensions sit outside of the IHT net, allowing individuals to pass on their unused pension funds free of inheritance tax. However, from 2027, unused pension wealth will become part of the taxable estate, meaning it will be liable for IHT at 40% on amounts exceeding the nil-rate band.

Unlike some gifting strategies, gifts out of surplus income do not require the donor to survive for seven years to escape IHT. Instead, provided the gifts form part of the transferor’s normal expenditure, were made from income, and left the transferor with enough income for them to maintain their normal standard of living, the gift is then immediately exempt from IHT.

Quilter said this could makes the strategy “particularly attractive” in light of the upcoming pension changes.

“For those who can afford to make gifts from surplus income, this is an incredibly valuable strategy, as the relief applies immediately without needing to wait seven years, which is required for most other gifts above the £3,000 annual exemption,” Griffin added.

“However, good record-keeping is absolutely essential. HMRC requires clear documentation proving that gifts were made from surplus income rather than capital, and that they do not reduce the donor’s standard of living. Seeking financial advice can help ensure compliance and maximise the benefits of this overlooked exemption.”

---