7th September 2023

Inheritance Tax

Charity Can Cut
Both Ways

Normally, if your Estate, after taking account of all your allowable inheritance tax reliefs, is above the inheritance tax threshold, then upon death, the excess will attract an inheritance tax liability of 40%.

  • However if you leave a sufficient charitable legacy that IHT liability could fall to 36%.
  • You need to make a charitable contribution of at least 10% of the value of your Estate, after stripping away certain eligible reliefs, such as your IHT nil rate band (presently £325,000).
  • Depending upon the makeup of your Estate, the 10% test might only have to apply to part of it to attract that 36% tax rate.
  • In some cases, it is worth increasing the donation to the charity, as this might result in your non-charity beneficiaries receiving a greater pay out from the Estate, as a result of the reduced IHT rate. This may require the beneficiaries of your Estate to do a Deed of Variation within two years following your death.

Calculating Inheritance Tax (IHT) and looking for any Inheritance Tax liabilities including charity and charitable contributions

For example:

  • Andrea Jones died in March 2022. Her Estate on death was worth £800,000. The assets were solely in her name.
  • Andrea had made a gift to her daughter of £160,000, 4 years before she died.
  • She left a legacy to the RSPCA amounting to £60,000.
  • Once all the relevant calculations are done, the net value of the Estate at death is £635,000.
  • Here the legacy of £60,000 is less than 10% of £635,000, so the Estate does not qualify for the reduced rate.
  • It would, however, be possible for the beneficiaries of the estate to increase the charity legacy by another £3,500, by executing a Deed of Variation so that the 10% test is met.
  • This would reduce the IHT liability from £230,000 (40% rate) to £205,740 (the 36% rate). A tax saving of £24,260.
  • The charity benefits by a further £3,500 plus the non-charity beneficiaries could receive a further distribution from the Estate of £20,760.

You can break the Estate value down into 3 components:

  • General component – Assets owned in your sole name.
  • Survivorship component – Assets you jointly own which pass by survivorship or under a special destination in Scotland (for example -joint bank account or jointly owned property).
  • Settled property component – assets held within a Trust of which you are a beneficiary and have a right to receive income from.
  • You only need to make a 10% charitable legacy in respect of one of those components to attract the 36% IHT rate. That reduced rate would only apply against the value of that particular component, unless the Estate makes an election to merge two or more components.

For example :

  • Mary Rudge died in May 2022 leaving assets owned personally, valued at £850,000. This is the general component.
  • She left 10% of the residue of her estate to Cancer Research. The donated amount from this part of the Estate was £85,000.
  • Mary also held a joint bank account with her son, Jack, which had a balance of £80,000 at death. This is the survivorship component.
  • Once all the relevant calculations are done, the charitable donation in respect of the general component needed only to be £54,115 to pass the 10% test.
  • As regards that part of Mary’s Estate, the reduced tax liability would be £164,210, compared to £182,460 (40%).
  • Taking account of the rest of her Estate, her total IHT bill potentially stands at £173,750.
  • However, where the amount qualifying for charity exemption in one component exceeds the 10% test (as is the case here), the beneficiaries may want to consider making an election to merge the components to gain the maximum benefit from the reduced rate. In this case that would reduce the IHT liability by a further £954.
  • The non-charity beneficiaries would receive an increased distribution of £19,204 in total.

Tip
The wording of the Will is important in this case, as is recognising the make-up of the person’s Estate and to do a review of the situation, within 2 years following the death to ensure that a Deed of Variation and/or an election is not missed. We are happy to provide advice on all aspects surrounding inheritance tax planning.

Looking for tax saving relating to Inheritance Tax (IHT)

 

You can read our last Pay Less Tax article from Winter 2024.

We also have an article on “All is not Inheritance Tax lost”.

But if you are interested in other articles, you can find them here.