Gifting to charity in your will

Bequests to charity in wills rise 61% in a year, but why? What are the benefits of gifting to charity?

The year 2020 was unprecedented, full of fear and restriction and as a result it made many people think more about end-of-life planning. With the nation being in and out of lockdown for over a year, it has given us all a chance to think about what we value, issues that range from the environment to healthcare, and how we wish to express this. Notably, Co-op Legal Service reported a 61% increase in the number of people leaving a gift to charity through their will, known as a charitable bequest.

Outside the context of the global pandemic, there are many reasons why you might gift some money to charity, but many are unaware of the inheritance tax benefits. Whilst Inheritance tax mitigation is unlikely to be the driving force behind your decision, there are benefits to doing so.

What is inheritance tax?

Inheritance tax (IHT) is a tax on your wealth that is paid on your death and on certain lifetime gifts. It is one of the highest taxes levied on individuals in the UK, at a current rate of up to 40%.

It can arise when an individual gifts assets from their estate, either during their lifetime or on death, that exceed their nil-rate band threshold (a lifetime gift, unless exempt, will use up some or all of the donor’s nil-rate band for the following 7 years). The nil-rate band is the value of your estate on which you don’t pay IHT, and it stands at £325,000 until April 2026.

In addition to the nil-rate band, there is a tax-free threshold of up to £175,000 for individuals who wish to transfer a qualifying property (which has been their main residence at some time) on death to their children, grandchildren or other ‘direct descendants’. This was introduced in 2017 to combat the issue of rising house prices inflating the value of estates and brings the total potential threshold for some individuals up to £500,000, or £1 million for a married couple.

Despite this, many estates are still liable to pay inheritance tax, however with proper planning, we can help to mitigate some of the liability by exploring methods that suit your individual circumstances. One of these may be gifting to charity.

Inheritance and gifts to charity – what are the benefits?

There are two main ways that you can gift to charity; the first is through a lifetime gift and the second is through a charitable legacy, left in your will. As a rule, a lifetime gift will typically fall into 1 of 3 categories:

1. Exempt Transfer
2. Potentially Exempt Transfer (PET)
3. Chargeable Lifetime Transfer (CLT)

Gifts to charities are classified as exempt transfers regardless of the size of the gift, however, for it to qualify, the gift must be made to a charity which is:

• based in the UK, EU, Iceland, Liechtenstein or Norway;
• established for charitable purposes only;
• registered with the Charity Commission or another regulator, if this applies to you; and
• run by ‘fit and proper persons’ recognised by HM Revenue and Customs (HMRC).

Once the gift has been made the value of the estate is immediately reduced by the value of the gift.

This is highlighted in the example below.

Example 1:

Sam has an estate valued at £425,000. He has never been married and has no children and therefore has a nil-rate band available of £325,000. He has gifted a qualifying charity £5,000. Should Sam pass away tomorrow the value of his estate will be £420,000 (£425,000 less the £5,000 donated). As this gift is immediately removed from his estate for IHT purposes, the charitable donation will save his beneficiaries £2,000 in tax (£5,000 x 40%) and may also save Sam other taxes such as income tax. 

The same principle would apply should Sam have made this gift through his will instead of during his lifetime.

Should Sam leave at least 10% of his net estate to charity - that is his estate after deductions of his available nil-rate band, he would qualify for a reduced 36% IHT rate on his taxable estate which means he might be able to pass down more assets to the beneficiaries in his will. The residence nil rate band is not deducted from the value of the estate as part of this calculation. Let’s better explain in the following example:

Example 2:

Sam’s estate is valued at £425,000, and therefore the value of his net estate is £100,000 (£425,000 - £325,000 nil-rate band) and would be liable to the standard 40% IHT rate, resulting in a £40,000 tax charge.

However, if Sam were to include in his will that he wished to gift 10% of his net estate, £10,000 (£100,000 x 10%) to charity, the balance of £90,000 will be subject to the reduced 36% IHT rate. In this case, Sam’s estate would owe IHT of £32,400, instead of £40,000, saving £7,600.

As a result of this, not only has Sam gifted more to charity, but he is able to pass on more of his assets to his beneficiaries than if he had gifted £5,000 (as seen in Example 1).

Of course, charitable gifts are just one of the range of options that can be considered when looking at IHT planning, alongside trusts and other gifting. To understand your financial circumstances regarding inheritance tax, why not get in touch and arrange a free consultation with an adviser today!

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The Financial Conduct Authority does not regulate estate planning, tax or trust advice.