Leaving a sum of money for charity in your will is a final act of generosity that can go a long way to helping others – but it also has the added benefit of helping to minimise your IHT obligations.
The UK is a nation of givers. The act of helping others in need is ingrained in British culture, with the UK ranked the fifth most generous country in terms of donating money in 2021, a year when 65% of the population gave to charity, according to the Charities Aid Foundation. But beyond the benevolence of giving, did you know gifting to charity can also help reduce your inheritance tax?
Often named the most disliked tax in the UK, inheritance tax is a 40% charge on the value of everything you own beyond a nil rate band of £325,000, plus £175,000 if you own your home where this is inherited by children or grandchildren. If the estate of the first person in a marriage or civil partnership to die is passed in full to their surviving partner, that person inherits their allowances. This means your nil rate band could be up to £1 million, though it will begin to taper if your overall estate is worth more than £2 million (this means estates worth over £2M will start to lose the residence nil rate band (RNRB), as it will be withdrawn at a rate of £1 for every £2 over £2M).
If your estate is likely to be valued above your nil rate band when you die, inheritance tax could significantly reduce the legacy left to your loved ones. However, a final act of philanthropy, in the form of a gift to a charity in your will, could help reduce your IHT liability quite considerably.
The gift of giving
There are two ways in which gifting to charity can optimise your legacy planning. Firstly, any money left to charity is exempt from inheritance tax and reduces the value of your estate for IHT purposes. Secondly, a little known relief is triggered when you donate at least 10% of your net estate to a qualifying charity or charities, reducing the IHT rate payable from 40% to just 36%.
"A lot of people don’t realise that it’s 10% of your net estate, not 10% of all of your assets,” says Gill Philpott, Tax and Trust Specialist at Ascot Lloyd. “Calculating your net estate means subtracting numerous things from the total value of your estate including your nil rate band, debts, funeral expenses and any other IHT exemptions that might apply such as business relief.
"Because it's 10% of the net estate, it could actually be a relatively small gift that needs to be made to qualify for the 36% rate. Due to a lack of awareness about the reduced rate, some people will specify a sum to leave to their favourite charity in their will without realising that if they gave just a small amount more, they would have qualified for the 36% rate.”
Getting it right
These calculations can be complicated, particularly as the value of your estate may well increase after you write your will, which could mean a gift you originally thought would enable your estate to qualify for the reduced IHT rate no longer does. Having a legal professional, such as a solicitor help draft your will, will mean that the will can be drafted to ensure the gift value meets the 10% test, and could prove invaluable.
“I would recommend taking professional advice when writing your will. Using a templated document or writing the will yourself, even a straightforward one is not recommended,” Philpott adds. The fee a solicitor is likely to charge will be modest when considering that a will is an important legal document and needs to be correctly drafted. A will deals with your lifetimes wealth and how you wish it to be passed on. A will is a bespoke document drafted to fit your personal circumstances and fulfil your legacy wishes.
“If not appropriately drafted, a gift left to a charity can create issues for the charity. There are instances where people put restrictions on the gift or specify the gift can only be used by the charity for certain expenditure or grant making. As a result of the restrictions the charity cannot accept the gift as they will not be able to meet charitable objectives by using the monies in such a restricted manner. If you want to leave a significant sum and you have a charity in mind, it can be helpful to engage with them in your lifetime. Talk to them and understand what it is they need and how your money can best help and support them.”
Lifetime vs legacy
Meanwhile, a financial advice company with an in-house tax team, such as Ascot Lloyd, can assist in helping you devise the best gifting strategy to meet your financial and legacy goals. After reviewing your finances and objectives, it might even be that taking a lifetime planning approach to charity gifting, rather than a legacy planning approach, is more suitable for you.
For gifts to individuals or trusts, assets gifted more than seven years before you die are outside of your estate. If you die within seven years of the gift, its value is added to your estate for inheritance tax purposes. However, an allowance of £3,000 per year is exempt from the seven-year rule, rising to £6,000 if you didn't use last year's allowance. Normal expenditure out of income is another valuable exemption which helps mitigate IHT and with which it is irrelevant whether or not the donor survives for seven years or not. There are three conditions which if met means expenditure can be used to fund life policy premiums, make regular pension contributions for family or make regular gifts into trust without falling into your estate.
“If you make donations to a charity during your lifetime and you are a taxpayer, you can get income tax relief, reduce the value of your estate for IHT purposes and the charity can claim gift aid relief,” says Philpott. “So, as you approach your latter years and you've got a taxable estate, a review from a financial adviser and tax professional might find it's more tax efficient to gift during your lifetime. That way you also get the added benefit of being around to see the gift being utilised.
"Because of the size of Ascot Lloyd, there is a dedicated tax team with tax and trust qualified individuals on hand to support clients in making the right decisions. Ascot Lloyd financial advisors can therefore look after your money during your lifetime, work with your beneficiaries to help them once they inherit, but also work with our in-house tax team to minimise your IHT while providing some sort of charitable benefit if that's what you wish to do."
If you'd like to find out more about how gifting to charity could reduce your inheritance tax liability, book a free callback from an Ascot Lloyd independent financial advisor.