Charities need our support more than ever nowadays as the long-term impact of the pandemic are still yet to be seen.
That said, despite the challenges, charitable giving has remained strong in the UK with an increase of nearly £800m being donated to charity between January and June 2020 when compared to the same period in 2019 (Charities Aid Foundation UK giving 2021 report – see here).
Helping those less fortunate or in need can be incredibly rewarding, however, there are some interesting tax benefits that can be gained if you take a little extra time to consider how you can give to charity.
Let HMRC foot the bill!
It’s widely known that leaving gifts to your favourite charities in your Will go straight to the charity free from inheritance tax. However, a less well-known fact is that by simply giving a gift to charity you can potentially reduce the rate of inheritance tax you pay on the rest of your estate.
The rules are relatively straightforward. If you leave at least 10% of your taxable estate (the amount above the available nil rate bands) to charity then your inheritance tax rate becomes 36% on the remainder, rather than the normal 40%.
With the available nil rate bands (including the residential nil rate band) currently standing at £1m for a married couple or civil partnership, even a modest amount to charity can have a massive impact with HMRC picking up much of the tab.
Example 1 (see below) demonstrates that with careful planning, your beneficiaries can potentially end up receiving virtually the same amount, even though a much larger charitable donation has been made:
| No Charity Donation | Smaller Charity Donation (5% of taxable estate) | Larger Charity Donation (10% of taxable estate) | |
|---|---|---|---|
| Estate on second death | £1,250,000 | £1,250,000 | £1,250,000 |
| Taxable estate after nil rate bands* | £250,000 | £250,000 | £250,000 |
| Charity donation | £0 | £12,500 | £25,000 |
| Amount subject to IHT | £250,000 @ 40% | £237,500 @ 40% | £225,000 @ 36% |
| HMRC receives | £100,000 | £95,000 | £81,000 |
| Charity receives | £0 | £12,500 | £25,000 |
| Children receive | £1,150,000 | £1,142,500 | £1,144,000 |
| * Two nil rate bands of £325,000 and two residence nil rate bands of £175,000 each (2021/22). £1million in total. | The children receive £1,150,000 after 40% tax has been deducted. | The children receive £7,500 less than if there had been no charity donation, however, the charity receives £12,500. | The children receive £1,500 more by doubling the donation from £12,500 to £25,000. |
By increasing the charitable legacy in the above client’s Will, the charity has been given double the original legacy and the children receive more too. Essentially, HMRC are footing the bill for over 75% of the charitable legacy due to the reduced rate of inheritance tax applying.
60% inheritance tax – no thanks!
In April 2017, HMRC announced the residential nil rate band, which was designed to ‘top up’ the standard nil rate band so that, from April 2020, a couple has a combined inheritance tax allowance of £1 million.
Of course, it’s not as simple as it sounds especially for those with larger estates worth £2million+. If this applies to you, read on….
HMRC take this additional allowance away at a rate of £1 for every £2 over £2 million. As such, if a couple were to have an estate worth £2.7 million, they would lose all of the main residence nil rate band and be back to the standard £650,000 between them. As a result, there is a 60% inheritance tax trap that applies on the first £700,000 above £2 million – ouch!
The good news is that the £2 million test is a simple ‘snapshot’ of your estate on death. Our couple could consider giving the £700,000 to charity. Of course, it means that their assets will reduce and their children will eventually receive less but the effect is not as pronounced as you might think, as shown in the example below.
| No Charity Donation | Gift of £700,000 in Will | |
|---|---|---|
| Estate on second death | £2,700,000 | £2,700,000 |
| Charity donation | £0 | £700,000 |
| Revised estate | £2,700,000 | £2,000,000 |
| Standard nil rate band | £650,000 | £650,000 |
| Residence nil rate band | 0 | £350,000 |
| Taxable estate | £2,050,000 @ 40% | £1,000,000 @ 36% |
| HMRC receives | £820,000 | £360,000 |
| Charity receives | £0 | £700,000 |
| Children receive | £1,880,000* | £1,640,000** |
| * £2.7m less £700,000 tax ** £2m less £360,000 tax | £700,000 has been given to charity, but the amount that the children will eventually receive is only £240,000 less than if no donation had been made. |
Particularly for larger estates, charitable legacies in your will could go far beyond a one-off donation and help create an incredibly powerful and long-lasting philanthropic legacy for your family. For example, a £700,000 legacy could be invested to provide annual grants to a variety of charities each year.
Of course, there are no guarantees and investments can go down as well as up, but based on a 5% withdrawal rate, it would mean £35,000 a year to worthy causes – now, that’s a powerful legacy!
For me, leaving charitable legacies in wills is all about directing the capital that you’ve worked hard to accumulate over many decades to the causes you hold closest to your heart.
If you are interested in discussing how charitable giving can form part of your legacy, please get in touch.
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