.svg)
%20(1).jpg)
It is striking how little attention one of the most generous IHT exemptions on the statute book actually receives. The Telegraph reported last year that only around 430 families used the gifts out of surplus income exemption in the 2022 to 2023 tax year. Set against the £8.2 billion HMRC collected in inheritance tax in 2024 to 2025, and the trajectory we are now on, that number is remarkable. It is also about to look like a serious, missed opportunity.
From 6 April 2027, most unused pension funds fall inside the deceased's estate for IHT. The nil-rate band stays at £325,000 and the residence nil-rate band at £175,000, both frozen until at least April 2031 following the Autumn Statement 2025. Business Property Relief (“BPR”) and Agricultural Property Relief (“APR”) combined being capped at £2.5 million per person from April 2026, with anything above that taxed at an effective 20 per cent.
None of this is news to anyone in the private client world. What is less appreciated is what it does to the planning hierarchy. With pensions losing their IHT shelter, with the seven-year clock starting later for many people who only begin gifting in retirement, and with the nil-rate band quietly being eroded by inflation every year, the lifetime exemptions that survive untouched become more valuable than they have ever been.
And the most powerful of those, by some distance, is the one in section 21 of the Inheritance Tax Act 1984.
What makes this exemption different from everything else?
The basic mechanics are well known but worth restating because they are unusually generous. A gift qualifies as exempt from IHT, with no seven-year clock to survive and no aggregation with later transfers, if it forms part of the donor's normal expenditure, is made out of income rather than capital, and leaves the donor with enough income to maintain their usual standard of living.
There is no cap on the amount. None. A retired client with significant pension income, surplus dividends, or rental income can give away tens of thousands of pounds a year and the entire transfer falls immediately outside the estate. Compare that to a potentially exempt transfer (“PET”) where the donor has to survive seven years for the gift to drop out of the estate completely.
What makes section 21 particularly interesting now is that pension drawdown may count as income for the purposes of the exemption. HMRC confirmed in its technical guidance last year that the 2027 changes to pensions and IHT do not alter the position on lifetime transfers. So a client drawing more from their pension than they actually need for day-to-day living can, in principle, route that surplus straight to children or grandchildren and keep it out of the estate. Given that the same pension will be inside the estate at death, that is a meaningful planning opportunity. A question I have been asked more and more this year is whether this changes the basic argument for drawing down earlier rather than later, and whilst every clients position may be different, for many clients the answer is now yes, provided the gifting is set up properly.
Why is the exemption so underused?
I think there are two reasons, and they are related. The first is that the exemption looks deceptively simple. Three conditions, no monetary cap, no seven-year wait. People assume their accountant or solicitor will sort it out when the time comes. The second is that the work is at the front end, not the back end. The exemption is not claimed by the donor in lifetime. It is claimed by the personal representatives at probate, on form IHT403, after the donor has passed away and is no longer there to explain anything.
If the pattern of gifts and the supporting evidence have not been built up methodically during life, the executors are left trying to reconstruct it from bank statements and best guesses, and that is precisely the point at which HMRC tends to push back.
The recent First Tier Tribunal decision in Hosking v HMRC, handed down in April 2026, is a useful illustration. Jeremy Hosking made political donations of around £1.7 million over a nine-month period to campaigns supporting the UK leaving the EU. He earned substantial investment income, well in excess of his living costs, and had a long track record of significant charitable and political giving, around £10.8 million and £11.9 million respectively over a seven-year period.
On paper the surplus income was clearly there. The exemption was nonetheless denied. The Tribunal found there was no settled pattern: the donations fluctuated with the campaign's needs and his available cash rather than the level of his surplus income, the nine-month window was too short to establish a habit of giving, there was no documented commitment, and Mr Hosking himself could not explain why he had given the amounts he did at any given time. The Bennett principles from 1995 still rule the field, and the Tribunal applied them strictly.
Hosking is not really a case about scale. It is a case about evidence and structure. The donor had the income. What he did not have was a record of regularity, a documented intention, or a fixed enough pattern to convince a Tribunal that the giving formed part of his normal expenditure rather than a series of one-off decisions driven by external events.
Strip out the political content and the lesson is uncomfortably applicable to ordinary estate planning. Most families gift in exactly the way Mr Hosking did: irregularly, in amounts that move with circumstances, with no written intention behind any of it. That is the version of gifting HMRC challenges at probate, and that is the version that fails.
What does a defensible pattern of giving actually look like?
The conditions in section 21 do not require the gifts to be identical in amount, but they do require something HMRC and the courts can recognise as habitual. The cleanest version is a standing order of a fixed sum to the same recipient each month or each quarter, set up by a letter of intent that records what the donor is doing and why.
The next cleanest is variable gifts tied to a variable income source, such as quarterly dividends from a family company, where the amount moves with the income but the rhythm does not.
Records matter as much as the gifts themselves. An annual schedule of income, outgoings and surplus, kept by the donor while they are alive and refreshed each tax year, is the document the executors will rely on. It does not need to be elaborate. It does need to exist.
The second condition, the standard of living test, is where I find clients tend to underestimate the risk. HMRC's manual at IHTM14255 is explicit that if the donor has to dip into capital to meet ordinary living costs, the exemption is not available in full. In practice this is often the issue with retired clients who set up generous gifting arrangements in good health and then face unforeseen care costs five or seven years later. The exemption is not automatically lost in that situation, but it tightens significantly, and the contemporaneous record of why the original commitment was affordable becomes the only thing standing between the family and a significant IHT adjustment on the IHT return.
Where does this sit alongside the 2027 changes?
For clients who will be affected by the pension changes, the question I keep coming back to is the order of operations. Drawing pension income into the estate, then gifting it back out under section 21, can move significant value off the IHT balance sheet without any of the seven-year exposure that PETs carry.
For clients with surplus dividend income from family companies or from investment portfolios, the same logic applies and has applied for years, but the relative attractiveness goes up sharply as other reliefs are restricted. With BPR and APR now capped, with pensions losing their shelter, and with the nil-rate band frozen for another five years, the planning architecture is narrowing.
Section 21 is one of the few remaining levers that does meaningful work without complex structuring.
None of this is exotic planning. It is good housekeeping. But it is housekeeping that has to be done in lifetime, while the donor is around to explain what they are doing and why, and while the bank statements and the letters of intent can be assembled with care rather than reconstructed under pressure.
Estates that arrive at probate with three or four years of clean section 21 records, properly tied to income and surplus, sail through. Estates that arrive with a series of one-off transfers and a hope that HMRC will join the dots tend to find that HMRC does not.
There is time to put this right. Pattern is what the exemption rests on, and pattern can take time to build. Clients who start now will have something defensible in place by the time the pension changes bite. Clients who wait until the legislation lands will not.
This article has been prepared for information purposes only. Formal professional advice is strongly recommended before making decisions on the topics discussed in this release. No responsibility for any loss to any person acting, or not acting, as a result of this release can be accepted by us, or any person affiliated with us.
.avif)
.svg)
%201.svg)
