Helping clients and charities at HMRC's expenses
Solicitors should encourage clients to take advantage of the underused, invaluable tax relief available when leaving money to charity, advises John Bunker
Are your clients making the most of tax effective giving to charities through their wills and variation of inheritances from estates? A will, or variation, can help charities more than many clients and solicitors realise. Thanks to the invaluable, but underused, lower inheritance tax (IHT) rate when 10 per cent of a net estate is left to charity, this need cost your clients or their families very little. Sometimes they can actually benefit at the government’s expense.
Lifetime gifts and gifts made by will to charities are free of IHT. However, if at least 10 per cent of a taxable estate goes to charity, the IHT payable on the rest of the estate is reduced from 40 per cent to 36 per cent. The saving means that the gift costs only 24 per cent of the amount going to the charity. Some think that the 10 per cent amount is larger than it is in practice, and thus don’t utilise the opportunity enough.
The same saving can be made by varying an inheritance from a relative or friend within two years of their death. This could be a deed of variation under section 142 of the Inheritance Tax Act 1984, or a variation of a trust that includes charities as potential beneficiaries under section 144 of the Act.
Even better, if the deceased’s will has left 4 per cent of their taxable estate to charity, increasing the gifts to (any) charity from 4 per cent to a total of 10 per cent actually leaves the residuary estate unchanged. If the charity gifts were in excess of 4 per cent, it is better still, as increasing the charity total to at least 10 per cent means the residue left over is greater. A residuary beneficiary can choose to redirect part of their inheritance in this way and be better off at the end of the day – the government pays for the whole of the gift.The following are some examples to illustrate this.
- Alice is a spinster who dies leaving £575,000 in her estate and a legacy of £20,000 to Age UK, with the rest to her nephew Peter. After deducting the IHT nil rate band (NRB) of £325,000, the 10 per cent is worked out on the £250,000 balance, meaning 10 per cent is £25,000 and 4 per cent is £10,000. The 10 per cent threshold is not met. The £20,000 passes to the charity free of tax so there is IHT of £92,000 to pay and Peter gets a residue of £463,000 (less estate expenses).
- If Peter varies the estate by completing a deed of variation within two years of Alice’s death, to leave just an extra £5,000 to his own choice of charity – it doesn’t need be Age UK – the total of £25,000 hits the magic 10 per cent. This reduces the IHT payable to £81,000, with that £11,000 saving shared between the new charity’s £5,000 and an extra £6,000 for Peter.
- Brian is divorced and dies leaving £675,000, and his whole estate to his son John. As his home qualifies for the new residence nil rate band (RNRB), he has an extra £100,000 IHT allowance. After deducting his £325,000 NRB and £100,000 RNRB, leaving £250,000 net, the figures could be similar to Alice. However, as Brian’s will leaves nothing to charity, John pays IHT on the estate of £100,000, leaving a net estate of £575,000 (less the expenses).If John made a deed of variation giving £25,000 to Oxfam, for example, the IHT payable is reduced to £81,000 and John receives £569,000. It only costs John £6,000 to give £25,000 to Oxfam (i.e. 24 per cent of what’s given).
- Clare and David are married and have a combined estate of £1.1m. With two NRBs of £325,000 and two RNRBs between them, in 2017/18 a total £850,000 can pass free of IHT. Their taxable estate is £250,000, which means they need to give £25,000 from the survivor’s estate to meet the 10 per cent, assuming the first to die leaves everything to the other. But the 10 per cent will vary each year – for example, the RNRB will increase to £175,000 by the 2020/21 tax year and there may be changes in their asset values. So it’s best for them to include a charitable legacy of 10 per cent by using a formula which can be applied at the time of death.
There is so much potential to save more tax by giving more to charity. Solicitors should aim to advise on the figures, and draft the provisions needed in a will or deed of variation, to take full advantage of this underused, invaluable tax relief.
John Bunker is head of private client knowledge management at Irwin Mitchell