Charitable giving: Reducing Inheritance Tax & Gift Aid
A total of £10.3 billion was given to UK charities in 2017 and cash remains the most popular donation method, although online transactions are increasing. In either circumstance, in a recent study of 12,000 people, 52% said they used Gift Aid. (Source: CAF)
Typically people make donations in their lifetime, but charitable gifts can be also made in your will, having a positive impact on any Inheritance Tax (IHT) payable.
Leaving something to charity in your will is undoubtedly a positive thing to do, but it may also save your beneficiaries money. All charitable giving is tax-free, but when including a charity in your will, the donation amount won’t be counted towards your total estate value when considering Inheritance Tax (IHT).
If you donate 10% or more of your estate (and are above the nil rate threshold, qualifying for IHT) you will also pay a discounted rate of 36%, rather than 40% IHT. This was introduced by former Chancellor George Osborne in 2012, with the intention to make “giving 10 per cent of your legacy to charity the new norm”. You can do this by leaving either:
- A fixed sum, called a pecuniary legacy. Bear in mind that the real values of pecuniary legacies decrease over time, due to inflation.
- A residuary legacy, which is a share of your estate after all other legacies and costs are paid.
If you inherit an estate and would like to alter the distribution to include a charity, you can do this with a deed of variation, which can be used by an individual to redirect their own inheritance.
Consider a higher-rate tax payer with an estate of £1 million:
For simplicity, let’s assume they are unmarried.
Upon death the IHT nil rate band is £325,000, so £675,000 of the estate is liable to 40% tax. £270,000 is paid to HMRC and £730,000 is available for beneficiaries.
Leaving 10% of the estate to charity means £100,000 for a worthy cause, the value of the estate for IHT is reduced to £900,000 and they qualify for a discounted rate of 36%. The inheritance tax bill has been reduced by £63,000 to £207,000 and £693,000 is left for beneficiaries; the £100,000 donation has effectively cost only £37,000.
Donating through Gift Aid means charities can claim an additional 25p for every £1 you give. It won’t cost you anything extra; the ‘top-up’ is collected from Income Tax you have already paid on the amount. Better still, if you are a higher or additional rate taxpayer you can claim back the difference between the tax you’ve paid and what the charity receive, via self-assessment.
Your donation qualifies for Gift Aid as long as it isn’t more than four times the amount you have paid in tax, for that year. (Income Tax or Capital Gains Tax).
Let’s assume a scenario where £200 per month is gifted between various charities.
Using Gift Aid, these charities will receive £250 per month. In this circumstance a higher-rate tax payer is able to reclaim £600 a year income tax via a self-assessment, ultimately the monthly donations cost the donor £150 per month.
Naturally, over an individual’s lifetime, regular gifting will reduce total estate value and therefore any IHT to be paid.
Let’s consider a £1 million estate again:
Using Gift Aid, for the charity to receive the same £100,000 previously arranged in a will, a donation of £80,000 is required. As a 40% higher-rate tax payer the donor is also able to reclaim £20,000 of income tax, reducing the cost further to £60,000.
Upon death the estate is now valued at £940,000. IHT would be charged at the standard 40% and £246,000 is paid to HMRC. In these circumstances £694,000 is left to beneficiaries, £1,000 more than if the donation was part of their will.
Making sense of your situation
Giving to charity in life and death has advantages for both the donor and recipient, but the most appropriate method depends entirely on personal circumstances.
The examples given are intentionally simplistic; many factors will impact IHT and the most efficient way of making a donation. Financial planning will help make your situation clear. It may also give you the confidence to make larger donations, safe in the knowledge that you have sufficient funds to provide income in retirement, after helping a worthy cause.