Simple charity gift tip can ‘reduce’ 40 percent inheritance tax rate

Inheritance tax (IHT) applies to a person’s estate, such as assets, property and money, when they die and depending on how assets are prepared, can leave families and loved ones with a hefty bill to pay.

Currently, the single person’s inheritance tax threshold is £325,000 and is referred to as the nil-rate threshold. Tax is only paid if the total value of the estate exceeds this figure, after which a 40 percent tax is applied.

However, if managed strategically, people can legally reduce the tax rate and pass on a lot more to friends and relatives and one way to do this is through charitable gifting.

Mark Greer, managing director of philanthropy services at the Charities Aid Foundation, said: “A gift to a UK charity is free from inheritance tax, meaning that the money is ‘removed’ from the value of a donor’s estate before tax is calculated.

“In addition to the donation being tax-free, gifts to charities can reduce the amount of inheritance tax paid on the rest of the estate.”

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The charity donation is taken off a person’s estate before inheritance tax is calculated and if large enough, the rate at which inheritance tax is levied on the rest of the estate is reduced.

Mr Greer explained: “If 10 percent or more of the estate is gifted to charity, then the rate of inheritance tax paid on the rest of the estate is reduced from 40 percent to 36 percent.

“Gifts in Wills can therefore make a difference to the causes that donors care about the most, whilst having a positive impact on the remainder of their estate.”

For many people, leaving money to charity in a Will can also provide a way to give a far more substantial donation than they ever could in their lifetime. Mr Greer explained: “For instance, a £100,000 gift to charity from a £1million estate only ‘costs’ the beneficiaries of the estate £24,000.”

These gifts are also very important to charities as according to Free Wills Month, most UK charities depend on legacies for up to half of their income.

The latest figures show that HMRC amassed a staggering £7.1billion in inheritance tax receipts in the year to March 2023. This is £1billion more than in the same period last year and continues the upward year-on-year trend.

The £325,000 nil-rate band has been frozen since 2009 and at present, looks to remain this way until 2028 – despite soaring house prices and inflation. However, some ministers have suggested that an increase in the threshold or a cut in the rate of tax could be on the cards in an effort to win votes at the next general election.

Mike Hodges, partner and head of the private wealth team at Saffery Champness, commented: “The Government’s decision in 2021 to freeze the inheritance tax thresholds, amongst numerous other reliefs and allowances, has had a marked effect and is clearly starting to bear fruit for the Treasury.

“The practical upshot is that more and more estates will continue to face an inheritance tax bill. The fact that on the same day that it was announced that UK Government borrowing in the same 2022/23 tax year was significantly less than forecast, some may argue that the frozen IHT thresholds are becoming an increasingly disproportionate measure.

“And, with inflation continuing to remain high, one that will feel fairly punitive for any families swept into its net. If this trend continues we may see it becoming harder for the Chancellor to resist the suspicion that he is looking to build a war chest for some tax giveaways before the next election.”

Rachael Griffin, tax and financial planning expert at Quilter added: “The ever-increasing tax revenue from IHT presents a conundrum for the Government as we approach election season.

“Rumours are already rife regarding potential crowd-pleasing policy changes the Government might enact to improve their chances of winning the next election.”

Ms Griffin said that while some reports suggest inheritance tax may be “ripe for reform”, it is becoming an increasingly powerful revenue generator, making the prospect of lowering it “a bitter pill to swallow”.

On the other hand, she said: “It is likely to drum up support.”