Let your head rule your heart

As chartered financial planners we see a wide range of financial planning needs including those of wealthier clients wanting to give something back through charitable giving. Of course, everyone involved wants the charity to receive the maximum benefit from any gift, so there are some financial and taxation considerations to think about first. Note, everything that follows relates to UK registered charities.

Lifetime giving

With most donations, charities ask donors to allow gift aid. This is a relief at income tax rates, which means the money is ‘grossed up’. For example, if £1,000 is earned and (after 20 per cent income tax) the remaining £800 is gifted, the charity can reclaim the £200 directly from HM Revenue & Customs, giving them the full £1,000.

If the money has borne 40 per cent income tax, there is no change from the charity’s point of view, but the donor can claim back the additional £200 via their tax return. Also, non-cash donations, for example of shares, are not counted as ‘disposals’ for capital gains tax purposes, and tax relief is given in just the same way as for cash.

The maximum tax relief on a donation is the amount of tax actually paid in the year or the previous year, if the donor elects to ‘carry-back’. So, for example, someone paying tax of £1,000 per annum can make gift-aided donations up to £4,000, but for anything over that, there is no tax relief. This point is particularly relevant if a client wishes to make a large donation from savings: spreading it over more than one year may result in fuller tax relief and ultimately more money to good causes. It’s also worth remembering that although the relief is at income tax rates, the tax paid includes income tax and capital gains tax.

Finally, and as a clarification, last year saw several ill-informed newspaper reports about higher-rate donors receiving large amounts of tax relief. To benefit from gift aid – and reduce your tax bill – you have to give money away. Therefore it isn’t a tax dodge, and there is no personal profit to be gained. The reports were sparked by draft tax legislation that would have limited the amount of tax relief available. However, gift aid has since been exempted from ?these regulations.

Bequests on death

The key problem with gifting significant sums during life is the danger of being left short. Also, many people simply prefer the idea of leaving money after they’ve gone. However, this usually isn’t best for the charity. For example, using the figures quoted earlier, a simple bequest of £800 will certainly be very welcome.

However, had it been made during life, gift aid could have increased it to £1,000. Inheritance tax doesn’t affect the donation because charitable bequests, of any size, are wholly exempt.

Inheritance tax

From April last year, legislation introduced a new idea: people leaving a bequest of ten per cent or more of their net estate (that is, after allowances and the £325,000 nil-rate band) will enjoy a lower overall inheritance tax rate of 36 per cent instead of 40 per cent. The benefit of the tax saving is to the estate, not the charity, although if it encourages charitable bequests overall, that must be a good thing.

For those people who would have left the ?ten per cent figure or more anyway, this reduction ?in tax will be extremely welcome; those still ?considering how best to donate, it is worth looking ?at all options carefully.

The gift aid advantages of gifting money during life are usually significantly greater than a four per cent inheritance tax saving. Other things being equal, that would be the preferred option. Unfortunately, though, it is often difficult to predict during life whether the money might yet be needed. And depending on the amounts, it may not be possible to achieve gift aid relief on the entire donation, or at least not unless the donation is phased over a number of years.

Where a bequest is the chosen route, it is worth being aware of a particular quirk, best illustrated by an example. Suppose a deceased client leaves a net estate (after the £325,000 nil rate band) of £500,000. Of this, £35,000 is left to charity and the balance to family. The family pay inheritance tax at 40 per cent and are left with £279,000. If the will had stipulated £50,000 to the charity, that is at least ten per cent of the net estate, the children don’t receive less – they actually receive more. With the tax rate now 36 per cent, they actually receive £288,000.

This win-win scenario means £9,000 extra for the children and £15,000 extra for the charity. If not foreseen before the event, a deed of variation (within two years of death) may be used to rearrange matters to everyone’s benefit.

Community foundations (England only)

For people who want to be more actively involved and specific in their charitable giving, it’s surprisingly easy to set up a dedicated charitable fund. This involves a sum of money being donated into an invested fund that provides for the local good causes specified by the donor. The key advantage is that all of the investment, regulatory and administrative matters are taken care of by an overarching organisation called a community foundation (itself a charity).

There are 54 community foundations, which ?are geographically based, reflecting a common ?desire among donors to help a particular local community. Gift aid still applies and depending on the way the money is to be used, it may also be eligible for a matching grant that boosts the amount by £1 for every £2. This means that a donation of, say, £1,000 could be worth up to £1,750 to the good cause.

Planning strategies

From the viewpoint of maximum benefit to the charity, the ideal model would be charitable giving during life (preferably on a regular basis). On the other side of the coin, a client’s financial security is usually best met by waiting until death. As planners, this presents several points:

• When considering giving assets, a really thorough assessment of the client’s present and future resources is crucial.

• Where possible, consider the advantages of ?lifetime giving rather than simply bequeathing the money. When a client understands the value of the 25 per cent uplift and potential personal higher-rate tax benefits, they are often pleased to adopt a fresh approach in the way they support their chosen charities.

• Where bequests are made, the possibilities of the 36 per cent inheritance tax reduction should be considered before death, but also by executors and estate professionals after death.

As advisers we tend to think more about building, maintaining and protecting family money rather than giving it away, of course. However, in the ?same way that a client may enjoy the prospect of giving something back, helping a client achieve ?their goal of charitable giving can also be very satisfying for us, especially when we have contributed, over the years, to the financial ?planning that made it possible.