Financial Focus On…Charitable bequests can benefit beneficiaries too

There is a sometimes overlooked rate of Inheritance Tax (IHT) of 36% (instead of the usual 40%) which is available on Estates that give a certain amount of their net worth to charity.  Interestingly, this reduced rate of IHT can generate a “golden band” where both the charity and the beneficiaries are better off.

The reduced rate of IHT applies equally to the original Estate and to any Estate varied by way of a Deed of Variation.  As you have two years from the date of death in which to make a Deed of Variation, executors may still be able to take advantage of the provisions if they were previously unaware of them. 

Broadly, the relief operates so that where 10% or more of a deceased’s net estate is left to one or more charities, the rate of IHT chargeable receives a 10% reduction (i.e. from 40% to 36%).  The “Net Estate” part is where the maths can become a little complex as this is calculated after deductions for any IHT reliefs, exemptions and available nil-rate band.  Where the Will provides for different “components” (for example these assets to go into Trust, those assets passing automatically to a surviving joint owner, those assets passing to general beneficiaries) it is possible to deal with these elements separately, partially combined or as a whole in order to determine the effect of the reduced rate of IHT.  Naturally, if there is no IHT due on an estate in the first place, these computations are irrelevant.

For most Estates where the deceased has already left charitable provisions in the Will, whether or not the reduced rate of IHT applies is a matter of fact and if the level of charitable giving is increased, this will only reduce the amount of distributable estate to the beneficiaries.  However, for Estates that are on the cusp of achieving the 10% level of charitable giving, there is a “golden band” where the reduction in IHT is greater than the increase in charitable gifts required to trigger it.  This can result in an increase in charitable giving AND an increase to the beneficiaries at the same time. 

For example, if we assume that when Dianne died she left an Estate of £600,000 (of which £25,000 is to charity) and was only entitled to the nil rate band exemption of £325,000.  First, you calculate the “baseline” amount from which the 10% threshold is taken.  In this case, this amounts to £600,000-£325,000 = £275,000.  The 10% threshold is therefore £27,500 in Dianne’s Estate.  Dianne is leaving £25,000 to charity (less than 10%) and therefore the 40% rate of IHT will apply.  The IHT due is (£600,000 – £25,000 – £325,000)@40% = £100,000 and the net amount to the beneficiaries is £600,000 – £25,000 – £100,000 = £475,000. 

Contrast this with the position were Dianne’s Estate to be varied by Deed of Variation to leave the minimum 10% to charity (£27,500).  Now the 36% rate applies which reduces the IHT to (£600,000 – £27,500 – £325,000)@36% = £89,100 and the net amount distributable to the beneficiaries increases to £600,000 – £27,500 – £89,100 = £483,400.  In this example, subject to the costs of preparing the Deed of Variation, by gifting an additional £2,500 to charity, the beneficiaries receive an additional £8,400.

The actual tipping point between the two rates of tax (and thus the location and width of this “golden band” where both the charities and the beneficiaries benefit) will be different for each individual Estate.  In some Estates, the additional donation needed to reach the tipping point will be too great to benefit from the tax saving.  In others, you may have already exceeded the 10% donation threshold and be entitled to the lower rate of IHT already.  However, for those just short of the 10% donation threshold, being a little more generous could put money in everyone’s pockets except the taxman’s!

Planning to take advantage of this band can be problematic as it will be difficult to know precisely the value of your Estate before you die though a good solicitor will be able to include a phrase into your Will to allow your charitable donation to be varied depending on the values and reliefs ultimately involved.  For deaths that have already occurred, executors can consider a Deed of Variation to take advantage of these provisions.  But whatever you do, you should ensure that your Will is up to date and contains as little ambiguity as possible (as the case of the RSPCA v Sharpe illustrated where a dispute arose with a charity over how a Will should have been interpreted).