Charitable Gifting and Inheritance Tax

Charitable gifting has been an effective component of estate planning, particularly for those with an estate that may face a significant inheritance tax (IHT) liability, such as, estates that exceed the nil rate band (currently £325,000).

However, incorporating charitable gifting into your Will can potentially reduce your estate’s IHT liability substantially. Understanding how this works and the potential benefits can help you make informed decisions about charitable gifting with effective tax planning.

What is Inheritance Tax?

Inheritance tax is a tax on the estate of a deceased person, including their property, money, and possessions, before distribution to beneficiaries. IHT is charged at 40% on the value of an estate above the £325,000 nil rate band threshold. Married couples or civil partners can potentially transfer their unused allowance to the surviving partner, increasing this threshold to £650,000. Estates may also qualify for residence nil rate band of up to £175,000 (or an increased allowance of up to £350,000 where there is transferrable unused allowance from a deceased spouse/civil partner).

For estates above these limits, the IHT liability can have a significant impact on the amount actually being left to the beneficiaries. However, gifts to charities are exempt from IHT which in turn could reduce the IHT liability.

How Charitable Gifting Reduces Inheritance Tax

The UK government has introduced incentives for charitable gifting through the Inheritance Tax Act 1984, which includes two key provisions:

1. Exemption for Gifts to Charity
   Any portion of your estate left to a charity is exempt from IHT. This means that charitable gifts, whether they constitute a small portion or a large percentage of your estate, will be deducted from the total value of the estate subject to IHT. The charities must be recognised in the UK to qualify for this exemption.
2. Reduced Rate of IHT (36%)
   If you leave at least 10% of your estate to charity, the IHT rate applied to the remaining estate is reduced from 40% to 36%. This can be highly effective for reducing your IHT whilst supporting causes important to you.

Examples of Charitable Gifting and Reduced IHT

Example 1: no charitable gift
Estate: £1,000,000
Nil rate band: £325,000
Taxable estate: £675,000
Gift to charity: £0
IHT: £270,000 (40% of £675,000)
Amount left to beneficiaries: £730,000

Example 2: charitable gift of less than 10%
Estate: £1,000,000
Nil rate band: £325,000
Taxable estate: £675,000
Gift to charity: £40,000
IHT: £254,000 (40% of £635,000)
Amount left to beneficiaries: £706,000

Example 3: charitable gift of 10% and reduced rate of IHT
Estate: £1,000,000
Nil rate band: £325,000
Taxable estate: £675,000
Gift to charity: £67,500 (10% of the taxable estate)
IHT: £218,700 (36% of £607,500)
Amount left to beneficiaries: £713,800
You can see that the charitable gift in example 3 would not only support a great cause but decrease the IHT liability and increase the amount left to beneficiaries compared to example 2.

Type of Charitable Gifts

The decision to include charitable gifts in your Will can be both a compassionate and financial consideration. There are several ways to give to charities:

1. Pecuniary Legacy
   You can leave a specific sum to charity in your Will. This is known as a pecuniary legacy and ensures a fixed amount will be deducted from your estate before IHT is calculated.
2. Leaving a share of your Residuary Estate
   A more flexible option is to leave a proportion of your estate to charity in your Will. This will allow the value of the gift to charity to adjust depending on the value of your estate.
3. Specific Legacy
   You can also choose to leave assets to charity. The market value of the assets at the time of your death will be deducted from the value of the taxable estate.

Common Mistakes

While charitable gifting is an effective method for reducing IHT liability, careful planning is essential. It’s important to work with a solicitor and/or financial advisor who specialises in estate planning to ensure that your Will is clear and tax efficient.

Some common mistakes to avoid include:

1. Failing to Meet the 10% Threshold.
   If you intend to qualify for the reduced tax rate of 36%, your charitable gift must constitute 10% of your taxable estate, not the whole estate. Miscalculating this could lead to a missed opportunity for tax relief.
2. Overestimating the Value of the Estate
   If your estate decreases in value, a percentage/share based charitable gift can inadvertently reduce the amount left to family members. This can be managed with careful Will drafting.

Additional Benefits of Charitable Gifting

Aside from reducing your tax liability, charitable gifts can create a lasting legacy. Leaving money to charity in your Will can create long term benefits for the charity and the community.

Charitable gifting offers significant benefits in terms of reducing inheritance tax. By taking advantage of the IHT exemptions and reduced tax rates, you can make a meaningful contribution to your chosen causes whilst reducing the tax liability on your estate. However, to maximise the financial and charitable impact, careful planning and expert advice are essential.

Arrange and appointment to see how Wilson Browne Solicitors can help. Call 0800 088 6004.