My wife and I are approaching our dotage, if we die without incurring care costs more than £45,000 of inheritance tax would require payment out of the longest survivor's estate. 

Over many years we have made equal regular gifts to our two daughters or their families at Christmas and birthdays out of our joint account and intend continuing to gift gradually increasing sums in this way, while also providing annual gifts up to the inheritance tax annual exemption.

In addition, we are considering reducing our inheritance tax by claiming the gifting out of income exemption regarding regular annual gifts made from our joint current bank account.

During our 56-year marriage, my wife and have had joint current bank accounts through which the majority of our financial affairs have and continue to be transacted. 

During this time, I have and continue to contribute most of our joint earned, pension, and investment income.

We are compiling records of our joint income and expenditure and have provided our daughters with a Deed of Gifting.

Does the gifting out of income exemption apply to married couples' joint income and expenditure or individually? J.C via email  

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Harvey Dorset, of This is Money, replies: The gifting out of income exemption that you refer to is officially known as 'normal expenditure out of income' and can be an effective way to pass wealth onto your children without falling foul of inheritance tax.

Inheritance tax rules limit what you can give away each year without it becoming potentially liable for inheritance tax (IHT). Gifts over and above these thresholds are usually only fully exempt from IHT if you survive for a further seven years.

For example, individuals can give away up to £3,000 each year, as many gifts worth less than £250 per recipient as they like, and give up to £5,000 for a child's wedding.

The rules exist to stop people giving away their wealth on their deathbed and dodging inheritance tax, but the limits have not been raised since the 1980s and were branded out-dated and in need of reform by an Office for Tax Simplification report in 2018 that was never acted on. 

Weddings, for one, are certainly a lot more expensive than £5,000 these days.

Gifting out of income allows you to make gifts that fall outside the £3,000 annual exemption.

In order to qualify, HMRC says taxpayers must satisfy the following for the gift:

• it formed part of the transferor’s normal expenditure
• was made out of income 
• left the transferor with enough income for them to maintain their normal standard of living

The first point above is an ill-defined grey area but is commonly judged to mean regular gifts. HMRC refers to a 'pattern of giving'. The second is meant to stop people giving away wealth, and the final point is the surplus income you refer to.

When making use of this exemption, it is essential to ensure that you have detailed records of your income in order to back up your case. These should track your income and expenses and record the gifts you make.

If you are going to pursue this, we highly recommend seeking help from an independent financial adviser or qualified tax adviser. 

Regarding your case, the vast majority of your income comes from you rather than your wife, but both of your incomes are combined in your joint account.

We asked two financial advisers to explain how this works and they said that although you pool money in a joint account, your separate incomes would be used to determine what income is being used to fund gifts out of your surplus income.

As your wife does not contribute much to your combined income, it is likely that she does not have surplus income, and in fact may be spending more money than her income.

As a result of this, the gifts you plan to make to your children will come out of your surplus income, as your wife would not be able to make a portion of the gift without affecting her living standards.

Because the gifts will come out of your income, you also need to account for the money you spend on your wife's living expenses as well as your own.

Our experts explain more. 

Simon Stygall, independent financial adviser at Flying Colours, replies: The late Labour Chancellor Roy Jenkins famously described inheritance tax as 'a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue'. 

Although there are other very effective inheritance tax strategies that do not involve absolute gifting (i.e., paying into a trust) during your lifetime, Jenkins' whimsical take on this 'voluntary levy', does, to a certain extent ring true as far as outright gifting is concerned.

Your current gifting strategy makes use of two very efficient exemptions:

1. The annual £3,000 exemption, which allows you and your spouse to individually gift £3,000 per annum, without consideration to IHT.

2. The normal expenditure out of income rule, which allows you to gift your surplus income on the condition that there is a regular pattern behind the gifting, and provided the gifting of surplus income does not impact your standard of living.

Firstly, regarding the 'annual exemption', it is important to remember that the £3,000 figure relates to the donor, and not the recipient of the gift. In addition, if the annual exemption wasn't used the previous year, this amount can be 'rolled over' to the following year, but only once.

It's also important to consider that this isn't the 'gifting limit' – indeed, there is no limit. Any outright gifts made in excess of your exemptions are classified as a 'Potentially Exempt Transfer'. The 'Potential' part being on the condition that you survive for seven years from the date that the gift was made.

Other available exemptions are the small gift allowance, which permits as many gifts of up to £250 per individual recipient as you wish to give (multiple small gifts to the same recipient will not be exempt). 

There's also the marriage exemption, which allows parents to gift an additional £5,000 to a child who is getting married, and grandparents an additional £2,500.

The normal expenditure out of income rule that you are using, is perhaps a lesser-known exemption, but one that can be extremely effective in managing inheritance tax. 

An important point is that the gifting is unlikely to be considered surplus 'income' if you then need to resort to capital withdrawals to maintain your standard of living.

 Moreover, the income needs to be 'true' income – investment bonds, for example are non-income producing, and as such, would be viewed as 'capital'.

With regard to what constitutes 'regular' gifts, HMRC's manual, at IHTM14243, reasons that 'A reasonable span would normally be three to four years. However, you can consider a longer period if this helps the taxpayer to illustrate the gifts were "normal"'.

However, a single gift may qualify as normal expenditure if it is intended to be the first gift in a pattern of gifts. Documenting the level and pattern of gifting as well as the 'normal' level expenditure is very important and HMRC's IHT 403 form can be used for this purpose.

HMRC, in their guide to completing your inheritance tax account, refer to the individual 'transferor's' normal expenditure and income. 

So, for absolute clarity when documenting the level of expenditure and income, you may decide to present this individually, rather than jointly. 

However, should you have any further questions or concerns with this, I would recommend speaking to an independent financial adviser.

What counts as surplus income? 

Ian Cook, chartered financial planner at Quilter Cheviot, replies: It's commendable that you're considering strategies to manage your inheritance tax liabilities effectively, especially through the use of gifting out of income exemptions.

The 'Gifting Out of Income' exemption can indeed be a powerful tool in reducing your IHT liability, particularly for those with significant income. T

his exemption allows you to make regular gifts from your surplus income, provided these gifts do not impact your standard of living. 

For married couples, both partners have individual allowances under this exemption, meaning each of you can give from your own surplus income, potentially doubling the benefit.

It's important to understand that for these gifts to qualify, they must be made from income rather than capital. Income includes salaries, pensions, dividends, rental income, and interest from savings. 

However, it's crucial to note that drawing down 5 per cent from an offshore bond, does not count as income for the purposes of this exemption as this is considered return of original capital. 

Therefore, any gifts made from such withdrawals would not qualify under the gifting out of income exemption.

A practical example of how this exemption can be used effectively involves a client who had significant income, but his son was initially hesitant to take money from him. 

The client had a substantial IHT position and his son was covering school fees for his own children. However, the father decided to make gifts out of his ordinary income equivalent to the school fees, allowing his son to redirect that money into his pension. 

This not only allowed the father to reduce his IHT liability but also enabled the son to benefit from higher-rate tax relief on his pension contributions. 

Essentially, the son managed to save 40 per cent tax on money that would have otherwise faced 45 per cent tax during his father's lifetime. The savings were then further enhanced when his son reclaimed the tax relief by contributing the money into his pension. 

It's crucial to maintain accurate records of your income, expenditure, and the gifts made, as these will serve as evidence that the gifts are genuinely made from income and not capital. This documentation is vital because, without it, HMRC may challenge the exemption. 

While gifts made under the gifting out of income exemption are free from IHT immediately, it's important to remember that other gifts outside this exemption, or those beyond your annual exemption of £3,000 per year, may still be subject to the seven-year rule. 

This means that if you pass away within seven years of making such gifts, they could potentially be included in your estate for IHT purposes.

Leveraging the gifting out of income exemption can be a highly effective strategy in reducing your IHT liabilities, especially when combined with other tax planning measures such as pension contributions. 

However, meticulous record-keeping and adherence to the income rules are essential to ensure these gifts qualify for the exemption. Given the complexity of these rules, you may want to seek personalised advice to ensure that your estate planning aligns with your goals and doesn't fall foul of the tax rules.