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The tax benefits of giving to charity

Giving to charity can support good causes and reduce your heirs' tax bill
January 17, 2018

While giving money to charity is a worthwhile thing to do in itself it can also be a good way of reducing tax liabilities, particularly if you have no close family or your family is already independently wealthy. 

Everyone has an inheritance tax (IHT) allowance of £325,000, known as the nil-rate band (NRB). If your assets exceed this amount your estate will face a 40 per cent IHT bill on the amount above this. If your estate exceeds £325,000 and includes a main residence, and you have direct descendants such as children or grandchildren to pass it on to you may be entitled to an additional residence nil-rate band. This is currently £125,000 per person, and will rise to £150,000 per person in 2019-20 and £175,000 per person in 2020-21. However this is not an option if you don't have direct descendants.

But if you leave money or assets to a registered charity in your will this will not count towards the total taxable value of your estate for IHT purposes. And you will still receive the IHT exemption however much you give to charity.

If you gift 10 per cent or more of the net value of your estate to a charity, the rate of the IHT your heirs pay reduces from 40 per cent to 36 per cent.

"This can mean your loved ones still receive 90 per cent of your assets but benefit from a saving on the amount of tax paid," says Gary Smith, chartered financial planner at Tilney Group.

For example, the estate of a single person with no children worth £425,000 would be subject to an IHT charge of 40 per cent on the £100,000 above the NRB, or £40,000. However if they gave 10 per cent of their net estate to charity – in this case £10,000 – their estate would only pay 36 per cent tax on the remaining £90,000 above their nil rate band, totalling £32,400.

It would also be possible to write off the whole IHT liability by giving the amount above the NRB – in this case £100,000 – to charity. And you could still leave gifts to friends and family worth up to £325,000 completely free of IHT, adds Danny Cox, chartered financial planner at Hargreaves Lansdown.

 

Charitable legacies

There are three main types of legacy you can leave to charity. A pecuniary gift is the simplest form of legacy and is basically a cash amount. This would involve you stating in your will that you wish to leave a certain amount of money to a particular charity. You could also leave assets such as property or shares. Or  you could make a residuary donation, whereby you leave all or a share of what's left over in your estate once other gifts have been made.

But there are potential issues you need to be aware of before deciding type of legacy to use. Giving a fixed sum, for example £50,000, to charities might seem like a straightforward thing to do when you are composing your will. But if the value of your estate falls substantially between the time you wrote the will and your death, you could end up leaving a greater proportion of your wealth to charity than you had intended. So you should update your will regularly, at least every five years. And if you want your heirs to benefit from an IHT discount for giving to charity, you will need to state that you want to give 10 per cent of your estate to charity.

Disputes between charities, families and executors can occur if a will has not been clearly drafted, particularly when it comes to residuary donations.

“Unfortunately some charities have made a bad name for themselves by beginning legal action against executors to maximise their claim [if they are named in a will],” says George Bull, senior tax partner at RSM UK Tax and Accounting. “The two most important things you can do when drafting a will are planning ahead and being very clear about your intentions. Make sure you take legal advice on how to draft your will and the wording surrounding the amounts you plan to leave to charity, as there's so much uncertainty surrounding death and wills.”

Martin Bamford, managing director of Informed Choice, adds: “Leaving money to charities and others should always form part of a wider financial plan. You should discuss your plans with close family members to establish expectations with all involved. The discovery of a large gift to a charity or a non-family member in a will can be an unwelcome shock which can lead to family disputes and contested wills. It's better to be open about plans and set reasonable expectations for future inheritance.”

If you have substantial assets and wish to pass these on to charities and/or other beneficiaries, like family members, you may want to consider using a discretionary trust, suggests Julia Rosenbloom, partner at Smith & Williamson. These vehicles give trustees discretion as to how, when, and for whose benefit to use some or all of the capital and income of the trust fund. Beneficiaries or a class of beneficiaries are named in the trust deed, and it is entirely up to the trustees which of the potential beneficiaries will benefit. Ms Rosenbloom adds that it is a good idea to write a letter of wishes when setting up a discretionary trust, which trustees can use to guide their decision-making after your death.

 

Tax relief from charitable giving during your lifetime

Tax relief from charitable giving is also available while you are still alive, and is particularly attractive if you are a higher- or additional-rate taxpayer. The relief in question is Gift Aid, income tax relief designed to benefit charities and community amateur sports clubs. If you are a UK taxpayer, Gift Aid increases the value of your charity donations by 25 per cent because the charity can reclaim the basic rate of tax on your gift – at no extra cost to you.

If you’re a higher- or additional-rate taxpayer, you can claim the difference between the rate you pay and basic rate on your donation, which you can keep or pass on to charity. For example, if you donate £100 to a charity – it can claim Gift Aid to make your donation £125. And if you are in the higher-rate tax band and pay 40 per cent tax on your income, you can personally claim back £25 – £125 x 20 per cent. To claim the relief you should indicate how much you've donated when you complete your self-assessment form.

“From a tax perspective, you and the charity might be better off with a gift made during your lifetime,” says Mr Bamford. “For anyone considering making a gift to charity, it would be worth doing the sums first to work out whether a lifetime gift or a bequest in your will is the better option.”

However, for a charity to claim Gift Aid on your donation, you must have paid UK income or capital gains tax in that financial year. Your donations will qualify as long as they are not more than four times what you have paid in tax in that tax year.

Robert Pullen, director at Blick Rothenberg, says: "Whilst it is obviously commendable to be philanthropic, a common trap is where individuals make the Gift Aid declaration but haven't paid sufficient tax to cover the amount the charity claims back from the government. Individuals should only make the declaration where they are confident they can meet this, as they will otherwise be required to pick up the tab."

Although cash gifts are the most common charitable gift, Mr Pullen thinks it is also worth considering the tax benefits of donating shares, especially as you can donate listed shares free of tax. "If an individual is considering making a donation but needs or wants to sell shares first, they would incur capital gains tax if the shares have increased in value since acquisition," he says. "To avoid this, they should take a leaf out of Bill Gates' book [who last year donated $4.6bn (£3.34bn) to charity, in the form of Microsoft shares]. Not only will they save on capital gains tax – up to 20 per cent of the gain – they will also get a deduction against their income for the value of the shares gifted, which gives effective income tax relief of 40 per cent."