Charitable Trusts

For those with philanthropic intentions, a charitable trust can be a powerful way to create a lasting legacy while achieving significant tax benefits. 

In this week's blog, I explore what charitable trusts are, their rules and requirements, how they're established, and the pros and cons for potential donors.

What is a Charitable Trust?

A charitable trust is a way to set aside money or assets to support causes you care about. It’s an irrevocable structure—once you move assets into a charitable trust, you give up personal ownership of them, meaning you can’t get them back or pass them on to your family. But in return, this kind of trust can bring meaningful benefits, both for the charities you want to help and for your own financial and estate planning.

Think of it as a mix between a generous gift and a smart financial plan. Instead of giving a large amount all at once – which might be hard for a small charity to manage – you can arrange for your donations to be made steadily over time. This makes your support more predictable and manageable for the charity, and it may also reduce your tax bill.

Furthermore, charitable trusts offer substantial flexibility. Trustees can pause, reduce or increase donations based on the trust's financial performance or changing circumstances. They can also substitute existing beneficiary charities for new ones if priorities shift, or add additional causes to support. This adaptability ensures your philanthropic vision remains relevant even as times change.

In the UK, charitable trusts are regulated by the Charity Commission and must be established for exclusively charitable purposes that fall within one of the following legally defined categories:

• Relief of poverty
• Advancement of education
• Advancement of religion
• Advancement of health or saving lives
• Advancement of citizenship or community development
• Advancement of the arts, culture, heritage or science
• Advancement of amateur sport
• Advancement of human rights
• Advancement of environmental protection
• Relief of those in need due to youth, age, ill-health, disability, financial hardship or other disadvantage
• Advancement of animal welfare
• Promotion of the efficiency of the armed forces, police, fire and rescue, or ambulance services

Tax Benefits of Charitable Trusts

Alongside the clear philanthropic objective, charitable trusts also provide significant tax advantages:

1. Income Tax Relief: Donors receive income tax relief on donations to charitable trusts. For example, if you donate £100,000 and are a higher-rate taxpayer (40%), the donation will be grossed-up to £125,000 via Gift Aid, and you’ll receive a further £25,000 back as a tax rebate. That implies a net cost of ‘just’ £75,000 for a £125,000 charitable donation. 
2. Capital Gains Tax Exemption: Assets donated to a charitable trust are exempt from capital gains tax, which can be particularly valuable when donating appreciated assets such as property or shares.
3. Inheritance Tax (IHT) Benefits: Assets placed in a charitable trust are immediately outside your estate for IHT purposes. Furthermore, if you leave at least 10% of your net estate to charity, the IHT rate on the remainder drops from 40% to 36%.

Here’s a worked example:

Case Study

John and Helen, both 65, have an estate worth £4.5 million and three adult children, each of whom is financially independent and successful in their own right. John and Helen want to make a significant charitable impact in areas of education and healthcare, causes that are important to them, while also reducing their potential inheritance tax (IHT) liability.

To do this, they set up the JH Family Charitable Trust and donated £1 million to it.

• The £1 million is immediately taken out of their estate, which could save £400,000 in inheritance tax (as charitable donations are exempt from this 40% tax).
• That money is then reinvested, and because the trust is a registered charity, any income or investment growth is completely tax-free.
• John and Helen can choose which charities receive support from the trust, as long as these fall within the agreed areas of education and healthcare.

This type of trust works especially well when people want to help several smaller charities. Instead of giving a large sum to each charity all at once – which can be difficult for smaller organisations to manage – the trust can provide regular, smaller amounts over time. This ensures the charities receive steady support without being overwhelmed.

Types of Charitable Trust

There are several types of charitable trusts in the UK, with the two most common being:

1. Grant-making Charitable Trusts: These trusts provide financial support to other charitable organisations or individuals who fall within the trust's charitable purposes. They can be structured to give specific amounts at set intervals, helping charities plan for the future while ensuring your donations are used exactly as intended.
2. Operating Charitable Trusts: These trusts actively engage in charitable activities themselves, such as running a museum, providing educational programmes, or delivering healthcare services.

Many families opt for grant-making trusts as they're typically easier to administer while still providing significant flexibility and impact. You can set restrictions on how funds are used and when they're distributed, ensuring your philanthropic vision is realised exactly as you intend.

Establishing a Charitable Trust

Setting up a charitable trust involves several key steps:

1. Define the Trust's Purpose

Clearly articulate the charitable purpose of your trust. This must fall within one of the categories recognised by UK charity law, as mentioned earlier.

For family charitable trusts, it's important to strike a balance between specificity (to ensure your charitable intent is preserved) and flexibility (to allow trustees to adapt to changing needs and circumstances over time).

2. Create a Trust Deed

This legal document outlines:

• The trust's objectives
• Powers of trustees
• Administrative provisions
• Rules for appointing and removing trustees
• Provisions for winding up the trust

This should be drafted by a solicitor experienced in charity law to ensure it meets all legal requirements.

3. Select Trustees

Choose a minimum of three trustees who will be responsible for:

• Managing the trust's assets
• Making grant decisions
• Ensuring compliance with charity law
• Filing annual accounts and returns

Trustees can include family members, friends, and professional advisers. However, having at least one independent trustee with relevant expertise can be beneficial.

4. Register with the Charity Commission

If your charitable trust's income exceeds £5,000 per year, you must register with the Charity Commission. Trusts with incomes below this threshold can still register voluntarily to gain the benefits of charitable status.

5. Apply for HMRC Recognition

To receive tax benefits, you'll also need to apply to HMRC for recognition as a charity for tax purposes. This allows the trust to:

• Claim Gift Aid on donations
• Benefit from tax exemptions
• Enable donors to claim tax relief on their contributions

Operating a Charitable Trust

Once established, the trustee responsibilities include:

• Investment Management: Ensuring the trust's assets are properly invested in line with the Trustee Act 2000. Many Charitable Trusts will delegate this responsibility to an adviser or investment manager.
• Grant Making: Developing and implementing a grant policy aligned with the trust's charitable objectives
• Record-keeping: Maintaining accurate financial records
• Annual Returns: Filing annual accounts and reports with the Charity Commission and HMRC
• Meetings: Holding regular trustee meetings to discuss strategy and make grant decisions

The Pros & Cons

In terms of the advantages of Charitable Trusts:

• Tax Efficiency: Significant immediate tax benefits including income tax relief, CGT exemption, and IHT reduction
• Control: Donors can specify how funds are used and remain involved as trustees
• Legacy: Creates a lasting philanthropic legacy that can continue for generations
• Family Involvement: Can provide a framework for involving family members in philanthropy

Whereas the drawbacks are:

• Set-Up Costs: Professional fees for legal advice and trust establishment can be significant
• Ongoing Administration: Annual compliance, accounting, and reporting requirements
• Minimum Size: Generally only cost-effective for donations of £100,000+ due to setup and running costs
• Permanence: Once assets are donated to the trust, they cannot be reclaimed

Conclusion

A charitable trust can be an excellent vehicle for those with significant philanthropic intentions, offering substantial tax benefits while creating a lasting legacy. However, they require careful planning, professional advice, and ongoing commitment to administration.

For those considering this option, I recommend consulting with both a charity law specialist and a financial planner to ensure the structure aligns with your overall wealth and estate planning goals.

Please note that the Financial Conduct Authority does not regulate tax advice or Trusts. Tax rules can change, and their benefits depend on individual circumstances. This blog is for general information only and does not constitute advice.

Happy Thursday!

Kind regards,
George