Using charitable bequests as part of an inheritance tax ‘IHT’ planning strategy can be an effective way to benefit from reduced IHT rates, whilst also supporting causes that are close to your heart.
What is a charitable bequest?
A charitable bequest refers to leaving a portion of your estate to a charity or multiple charities in your will.
Bequests can be structured in different ways, for example, cash donations, property, or specific assets such as shares.
Tax efficiency
In the context of IHT planning, charitable bequests can be extremely tax-efficient.
There’s scope to make a sizeable donation to your preferred charity, which is mostly funded by a reduced IHT charge, rather than from the ‘pockets of your beneficiaries’.
This is because they benefit from a ‘triple whammy’ IHT saving:
- The bequest itself is exempt from IHT,
- Where the legacy exceeds 10% of your ‘baseline estate’ (broadly, the value of your estate before the donation to charity has been deducted, fewer available reliefs, exemptions and the standard nil-rate band, but not the residence nil-rate band), a reduced IHT charge of 36% (vs standard 40%) shall apply on the residual,
- In certain instances, a charitable bequest can also result in the reinstatement of some/all of your residence nil-rate band entitlement, providing additional savings.
This is best explained by way of an example:
Example: Ben and Juliet have an estate worth £2.5m, comprising property of £1.5m and cash and investments of £1m.
On death, they plan to pass on all their assets to their two children.
Their current IHT liability, on the second death, is calculated as follows:
Estate value £2,500,000
Less nil-rate bands available (£650,000)
Less residence nil-rate bands available* (£100,000)
= Net estate liable to IHT £1,750,000
IHT due at 40% = £700,000
*Their residence nil-rate band ‘RNRB’ entitlement is tapered from the maximum £350,000 (£175,000 each) to a combined £100,000 due to the size of the estate – it is reduced by £1 for every £2 that the estate exceeds £2m.
In the example above, Ben and Juliet’s children would stand to inherit a combined £1.8m (£2.5m estate value less £700k IHT liability).
Ben and Juliet now wish to explore the potential to leave a sizeable bequest to their favoured charity/charities.
To qualify for reduced IHT rates, they must bequeath at least 10% their baseline estate, which is calculated as £185,000 (10% x [£2.5m estate value less £650k standard nil-rate bands]).
Assuming they leave exactly this amount – and note here, you could provision for a percentage of the baseline amount, rather than some notional value, in your will – their IHT liability would be recalculated as follows:
Estate value £2,500,000
Less charitable bequest (£185,000)
Less nil-rate bands available (£650,000)
Less residence nil-rate bands available** (£192,500)
= Net estate liable to IHT £1,472,500
IHT due at 36% = £530,100
**For the RNRB taper, the estate has been reduced from £2.5m to £2.315m (deducts the charitable bequest itself), resulting in the reinstatement of some of their residence nil-rate band.
The net result is that Ben and Juliet’s chosen charities would receive a substantial legacy of £185,000, whereas their children would inherit £1,784,900 (£2.5m estate less £530,100 IHT due less £185,000 charitable bequest).
Put another way, of the £185,000 charitable bequest, £169,900 (92%) is funded via a reduced IHT charge (down from £700,000 to £530,100) and just £15,100 (8%) via a reduced inheritance for the beneficiaries (from £1.8m to £1.785m).
Summary
In conclusion, leaving at least 10% of your ‘baseline estate’ to charity can be a powerful IHT planning tool that is often overlooked.
As shown in the example above, the maths can stack up very nicely, with most of the bequest funded via a reduced IHT charge.
Disclaimer: The Financial Conduct Authority does not regulate Inheritance Tax Planning. Inheritance Tax thresholds depend on your circumstances and may change in the future.
