Charitable Legacies

The normal rate of inheritance tax (IHT) payable on a persons’ chargeable estate on death is 40% and this is payable on the Estate after taking into account all exemptions, reliefs and the nil rate band (currently £325,000).

Since 2012 it has been possible to reduce the rate of IHT to 36% where 10% of the net Estate is left to a UK charity.

The rules are unnecessarily complex and a person’s estate can be made up of various components. The first step in establishing whether or not the reduced rate will apply is to identify the various components of a person’s estate as follows:

  • Jointly owned assets passing by survivorship – the survivorship component.
  • Assets owned in a trust of which the person was a beneficiary – the settled property component.
  • All other property owned – the general component.

Once the composition of a person’s estate has been established it is then necessary to calculate the donated amount which is the amount of the charitable legacy.

The next step is to calculate the “baseline amount” for each component which is the sum total of the various assets in those components less liabilities, exemptions, reliefs and the available nil rate band.

The baseline amount is then compared to the donated amount to see if the reduced rate of IHT applies. If the 10% test is met for any of the 3 components the reduced rate of IHT will apply to that component.

The relief is an “all or nothing” relief and if the donated amount is only 9% of the component then no relief is given.

It is possible to elect to merge components if there is a substantial gift out of one of the components, say the general component, which exceeds 10% of the overall estate.

To illustrate let’s assume that an estate contains the following:

  • Shares in a private trading company left to the son valued at £1m
  • A home left to the surviving spouse valued at £750,000
  • A legacy of £150,000 left to charity
  • Bank accounts and quoted shares left to daughter valued at £500,000

In determining the rate of IHT to apply we can ignore the private company shares which are covered by 100% Business Property relief and we can ignore the home which is covered by the spouse exemption. The baseline amount is therefore £650,000 less the nil rate band of £325,000 i.e. £325,000.

The donated amount of £150,000 is more than 10% of this amount and, as a result, the reduced rate of IHT of 36% will apply. The IHT payable will be £325,000 less the charitable exemption of £150,000 to give £175,000 chargeable at 36% which is an IHT charge of £63,000. Prior to the change in legislation the amount payable would have been £70,000. A saving of £7,000 which is well worth having.

If the Will currently contains a charitable donation of less than 10% of the baseline amount it is recommended that this is increased to 10%. There is no cost to the beneficiary of doing this as the whole cost of the increase is borne solely by H M Revenue & Customs.

If you assume that the baseline amount is £1,000,000 the following table shows the amount the beneficiary will receive if the charitable donation represents 3%, 4%, 5%, 9% and 10% of the baseline amount:

Charity % 3 4 5 9 10
IHT rate 40% 40% 40% 40% 36%
Beneficiaries receive £582,000 £576,000 £570,000 £546,000 £576,000

 

It can be seen therefore that increasing the charitable gift from 4% up to 10% of the baseline amount can increase the amount the charity receives by £60,000 with none of this additional bequest impacting on what the beneficiary actually receives. A win-win situation!

The legislation is complex and it is very likely, if you wish to ensure that the lower rate is achieved, that most will draftsmen will opt to use a formula to arrive at size of the charitable gift rather than specifying exact amounts as the 10% test depends on what is in the Estate on death and not what is in the Estate currently.

If you need any further advice on leaving a legacy to your favourite charity or advice on inheritance tax generally please contact either Robert Peel or Nigel Shaw in the first instance.