Charitable Giving as a Strategy for Reducing Inheritance Tax

by Vig Gunasegaran

Inheritance tax can be a significant concern for many families in the UK. The thought of a large portion of their hard-earned wealth going to the government can be unsettling, especially when there are ways to mitigate this financial burden.

There are various strategies available to minimise inheritance tax; the most appropriate options will depend upon your individual circumstances and objectives.  Speak to your adviser at Beechwood if you would like to learn more about all the options available to you.

One effective strategy that not only helps to support charitable causes but also reduces your inheritance tax liability is leaving money to charity in your Will. In this blog post, we will delve into how charitable giving can reduce inheritance tax, accompanied by a practical example.

Understanding Inheritance Tax in the UK

Let’s briefly recap what inheritance tax is.

In the UK, when someone passes away, their estate – including property, possessions, investments and cash – may be subject to inheritance tax if its value exceeds the current threshold (as of August 2023, the threshold is £325,000, per individual).

In 2020, the residence nil rate band gave homeowners an additional £175,000 allowance if their property was passed down to a direct descendent (a child or grandchild). This gives a total allowance of £500,000 per person. Married couples will have a combined allowance of £1 million.

The residence nil rate band allowance starts to reduce when an estate exceeds £2 million. If the estate is over £2.7 million, the full residence nil rate band will be lost.

In most cases, anything above this threshold is subject to a 40% tax rate. This can considerably reduce the amount of wealth that beneficiaries ultimately receive.

The Charitable Giving Solution

Charitable giving provides an opportunity to make a positive impact on the causes that matter to you and also to save money on inheritance tax. Through carefully planned charitable donations, you can reduce the taxable value of your estate, resulting in a lower inheritance tax bill.

Example: How Charitable Giving Can Save Money on Inheritance Tax

Let’s consider an example to illustrate how charitable giving can reduce an inheritance tax liability:

Scenario: Jane is a successful entrepreneur who lost her husband John 3 years ago.  John passed his assets to Jane, in full.  Jane has an estimated estate value of £2 million. She wants to ensure that her children benefit from her estate while also supporting her preferred charitable organisations. Her goal is to reduce the potential inheritance tax liability on her estate.

Steps Taken:

Identifying the Charitable Cause: Jane decides to leave a legacy to 3 registered charities that she has been supporting for many years.

Calculating the Tax Savings: Jane’s estate including her property is worth £2 million, which is £1 million above the joint married inheritance tax threshold (£2 million – £1 million). At a 40% inheritance tax rate, the potential tax liability would be £400,000 (40% of £1 million).

Charitable Donation: To reduce her taxable estate, Jane decides to include a donation of 10% of her net estate, or £100,000, in her Will for the charities that she supports.

Reduced Taxable Estate: By making the charitable donation of 10% of her net estate, Jane’s inheritance tax rate reduces from 40% to 36%. Jane’s taxable estate is now reduced to £900,000 (£2 million – £1 million – £100,000). This reduces her potential tax liability to £324,000.

In this scenario, Jane’s charitable giving allows her to support a cause she cares about and also helps reduce the inheritance tax liability on her estate.

See the table below for a summary:


£1 million in the estate after the use of allowances*
NO gift to Charity 4% gift to Charity 7% gift to Charity 10% gift to Charity
Amount to charity £0 £40,000 £70,000 £100,000
Amount to family £600,000 £576,000 £558,000 £576,000
Inheritance Tax £400,000 £384,000 £372,000 £324,000

*  This table only refers to the value of Jane’s estate in excess of the tax-free nil rate band.  Jane’s children would receive the first £1 million, tax free. 

As you can see, if Jane gives 4% of her excess estate to charity, the charity would receive £40,000.  Her children would receive £576,000, which is £24,000 less than if no charity gift was given, and inheritance tax would be reduced by £16,000.

However, if Jane’s gifted 10% of her excess estate to charity, the charity would receive £100,000 while her children will still receive £576,000.  This saves £76,000 in inheritance tax.

Conclusion

If you are considering your estate planning options, exploring the possibility of charitable giving in your Will could be a wise step to ensure that your wealth contributes to both your family’s well-being while also supporting causes you hold dear.

If you are considering inheritance tax and estate planning speak to your Beechwood adviser to discuss your individual circumstances and options which would be suitable for you and your family.

It’s important to note that tax laws and regulations may change over time, this information is based upon our understanding of HMRC rules and practice as of August 2023. This post is for information only and should not be construed as advice.