Charitable legacies: Should more people be using them?

The opportunity for an estate to benefit from a reduced rate of inheritance tax where the deceased left a charitable legacy was introduced in April 2012. 

HM Revenue & Customs’ most recent figures show that £39m of IHT was saved using this relief on the estates of those who died in 2015-16, with just under 9 per cent of taxable estates benefiting from the relief.

Summary

The 36 per cent rate is available where 10 per cent of the net estate is left to charity. Importantly, the 10 per cent threshold relates to a component of the estate. 

There are three components:

1. Survivorship component – assets held as joint tenants that automatically pass to the survivor.
2. Settled property component – the value of trust assets that fall into the deceased’s estate; for example, where the deceased was life tenant. The trust deed will determine the destination of the assets.
3. General component – the free estate, being assets that are directed by will.

The charitable legacy must be at least 10 per cent of the component’s baseline amount in order for the component to qualify for the reduced 36 per cent rate of IHT. 

It is possible to merge two or more components to achieve the 10 per cent threshold.

Baseline amount

There are three steps to calculating the baseline amount:

1. Calculate the value of the component at date of death, less exempt gifts.
2. Deduct the available nil-rate band. This includes any available transferable NRB and is reduced by failed gifts. However, the residential NRB cannot be deducted here. Where more than one component is held the NRB will be split proportionately unless the will directs otherwise.
3. Add the charitable legacy back in to establish the baseline amount.

A simplified example is provided in Box 1.

HMRC provides a calculator that will work out the baseline amount, available online at www.gov.uk/inheritance-tax-reduced-rate-calculator.

Tipping points

Where a will leaves a charitable legacy, every 1 percentage point increase between 4 per cent and 10 per cent will cost the beneficiaries 0.6 per cent, where they are otherwise paying 40 per cent IHT on it. At 10 per cent they effectively recoup 10 per cent of the IHT paid on their full residual legacy.

Increasing a charitable legacy from 4 per cent to 10 per cent results in the beneficiaries receiving the same net amount. 

The charity will benefit in preference to HMRC. This means that where a charitable legacy falls short of the 10 per cent test but exceeds 4 per cent, the beneficiaries varying some of their interest in favour of charity results in both those parties seeing an increase to their legacy, to the detriment of HMRC.