Gifting to charity and reducing your inheritance tax?

There is no denying the charity sector is feeling the strain. Running costs, declining government support and demand for services are rising, while disposable incomes are being squeezed by increasing taxes, frozen allowances and an uncertain economic climate.

As a result, organisations are being forced to think differently about how they raise money in the current climate. Some are placing a greater emphasis on “legacy fundraising” i.e. when someone designates part of their estate to a chosen charity in their will. Nevertheless, this method of fundraising could face future challenges.

Additionally, multiple news outlets are reporting that Prime Minister Keir Starmer is considering plans to increase inheritance tax revenue by tightening rules around the gifting of assets, among other suggestions, at the next budget. This could mean that charitable tax incentives would become less prominent as a way to mitigate tax for high-value estates, which could have an impact on the number of people who leave assets to charity in their will. While we await the outcome of the impending budget, for now, those looking to minimise their tax bill while doing good for the world have a golden opportunity.

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How can I reduce Inheritance tax by giving to charity?

Currently, gifts to registered charities are exempt from inheritance tax (IHT). This can either be done through donating during your lifetime, or on death through your will.

As a reminder, everyone has a ‘nil rate band’ exemption for IHT, (currently at £325,000 per person). Furthermore, if you are passing your main residence to your direct descendants, you can also benefit from an additional exemption of up to £175,000 – this is known as the “residence nil rate band”.

Case Study 1 Example:

Mr A has an estate valued at £550,000 including a £300,000 main residence that he is planning to pass on to his children. He also utilises his annual gifting allowance every tax year. As a result, Mr A will benefit from £500,000 of allowances, as per below:

£325,000 nil rate band
£175,000 residence nil rate band

The excess (i.e. £50,000) would ordinarily be taxed at 40%, leading to a £20,000 tax liability. However, if Mr A left £50,000 to charity, his estate (now £500,000) would fall within the respective nil rate bands, which means there would be no inheritance tax to pay.

Bequeath on death

Further to the above, you also have the potential to reduce the rate of inheritance tax to 36% if you leave at least 10% of your net estate to charity. This is typically achieved by leaving a charitable gift via your will.

The net estate "baseline amount" is calculated by deducting IHT exemptions, reliefs and nil-rate band from the total estate value (however this does not include the deduction of the residence nil-rate band).

If the value of the gift is at least 10% of the "baseline amount", the reduced 36% rate of inheritance tax will be applicable.

Case Study 2 Example:

Ms B has an estate valued at £1,000,000 including a £400,000 main residence that she is planning to pass on to her children. She also utilises her annual gifting allowance every tax year and was planning to leave £40,000 of her estate to charity.

To keep things simple, we are going to assume that she has her full nil rate band and residence nil rate band, as per Case Study 1.

This means we would calculate Ms B’s inheritance tax liability as follows:

Estate	£1,000,000
Net estate/ baseline value (Estate - NRB) taxable estate	£675,000
Charitable gift	(£40,000)

As the value of gift is below 10% of the baseline value (£67,500), IHT will be chargeable at 40%.

Estate	£1,000,000
Less nil rate band & residence nil-rate band	(£500,000)
Less Charitable gift	(£40,000)
Tax to be calculated using...	£460,000
IHT @40%	(£184,000)
Distribution to MS B's beneficiaries	£776,000

Nevertheless, if Mrs B gifted 10% of her net estate (calculated at £67,500 - detailed above) instead of £40,000, it would have the following impact:

Estate	£1,000,000
Less nil rate band and residence nil rate band	(£500,000)
Less Charitable gift	(£67,500)
Tax to be calculated using...	£432,500
IHT @ 36%	(£155,700)
Distribution to Ms B’s beneficiaries	£776,800

As shown above, the planning in this scenario has not only slightly increased the amount the beneficiaries receive, but also the charity has received a further £27,500. This represents a win-win situation for both parties.

Can I pay a lower rate of inheritance tax after someone has died?

This may be possible through a Deed of Variation. This is a legal document that allows the distribution of the estate to be altered by the named beneficiaries in the will.

A Deed of Variation can be used to re-direct 10% of the net estate to charity, which means the estate would pay a reduced rate of inheritance tax (36%).

A Deed of Variation needs to be carried out within two years from the date of death for it to be effective from a tax perspective. Furthermore, the relevant paperwork must be signed by all executors and the beneficiaries who may be disadvantaged because of the change.

To help you visualise these numbers, we've put together this Inheritance Tax calculator:

If you are concerned about inheritance tax, or how this relates to charitable giving, why not get in touch with The Private Office and give us a call on 0333 323 9065 or book a free non-committal initial consultation.

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This article is for information only and does not constitute individual advice. The information provided in this article is based on the current allowances and legislation and is subject to change.

The Financial Conduct Authority (FCA) does not regulate estate planning or tax advice.