Older people are no longer taking all of their 25 per cent tax-free pension lump sum in one go, tax experts have said. These payments are then passed on to children or grandchildren as “surplus income”
James Rodger Content Editor
14:08, 13 Oct 2025
A loophole in inheritance tax could allow state pensioners to pass on money without paying tax(Image: alvaro gonzalez via Getty Images)
A loophole in inheritance tax could allow state pensioners to pass on money without paying tax. Retirees are being advised to regularly gift cash to their children, potentially reducing their future inheritance tax bill with HMRC.
Tax experts have noted that older individuals are increasingly choosing not to take their entire 25% tax-free pension lump sum at once. Instead, these payments are being passed on to children or grandchildren as “surplus income”.
According to HMRC guidelines, gifts made from surplus income are exempt from the 40% tax levied on estates worth more than £325,000. These payments do not fall under the usual seven-year rule, meaning the money is immediately free from tax.
However, this is only applicable if the person making the gift can demonstrate that it came from income and that they still have sufficient funds to maintain their usual standard of living.
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Nick Nesbitt, head of private client at Forvis Mazars, commented: “There is a growing view that pension tax-free cash can be classed as income for gifting purposes, if taken gradually over time.”, reports Birmingham Live.
Eamonn Prendergast, chartered financial planner at Palantir Financial Planning, observed: “I’ve definitely seen an uptick in this, particularly among higher-net-worth clients. It’s not just from tax-free cash, but from other pension withdrawals and forms of income too.”
He clarified that successful implementation requires “the gifting has to be regular, sustainable, and not impact your standard of living, otherwise HMRC are likely to challenge it.
“In theory, this means you can pass your tax-free cash on completely tax-free but HMRC hasn’t clarified this position yet,” Mr Nesbitt explained.
Mr Prendergast stated: “Until HMRC provides proper clarity, this area will remain risky, but for clients who can afford it and keep thorough records, it can still be a valuable planning tool.”
Zoë Dagless, director at Meliora Financial Planning, commented: “I find this area particularly grey. Personally, I would err on the side of caution and say it’s unlikely [to be considered income for gifting purposes].
“Record-keeping is absolutely key; if clients can’t clearly show a pattern and that the gifts are genuinely from surplus income, it will be difficult to defend later,” Mr Prendergast cautioned.
Ms Dagless added: “I’d certainly welcome greater clarity from HMRC on what constitutes ‘gifting out of income,’ so the rules are more transparent and easier for clients to understand.”