- Understand how charitable gifts on death are deducted from the taxable estate
- Understand the different steps involved in the calculation of the 10% test
- How the 36% IHT rate is applied to multiple estate components
Three key takeaways
Making a gift to a registered charity within a will is not only a great way to leave a positive legacy but can help reduce the amount of Inheritance Tax (IHT) due on an estate.
The IHT reduction can be broken down into two key elements encouraging people to consider such legacies:
- The legacy is exempt from IHT allowing more of the wealth to benefit the charity
- Where 10% or more is left to charity, the rate of tax applicable to the taxable estate is reduced by 10% down to 36%.
The first is easy to understand as any amount left is deducted from the taxable estate and is not subject to IHT. This article looks to explain the ‘10% test’ in more detail and using examples, show how the reduced rate of IHT can be achieved.
Understanding the specific terms
Specific terms are used within the calculation, and it is important to understand these prior to working through an example:
Survivorship component – joint assets (joint tenancy) passing via survivorship
Settled property component – assets for which the deceased was beneficially entitled to for example the life tenant of a qualifying interest in possession trust
General component – the rest of the estate except the survivorship and settled property components as well as any property for which a gift with reservation (GWR) exists.
It is possible for one or more components listed above to be merged to enable the combined components to qualify for the reduced rate. Property in which a GWR exists is eligible to be merged even though it is not specifically as a component of the estate.
Available nil-rate band – Currently £325,000, increased by any transferable nil-rate band (TNRB) but reduced by previous chargeable lifetime transfers (CLTs) in the 7 years prior to death. The nil-rate band is not increased by any residential nil-rate band (RNRB) or transferable residential nil-rate band (TRNRB) that might be available on the estate.
Donated amount - the amount that qualifies for charity exemption
Baseline amount - broadly, the value transferred by a chargeable transfer but after adding back the amount that qualifies for charity exemption.
It is calculated in three steps:
Step 1
Establish the value transferred by the chargeable transfer that is attributable to each component above
Step 2
Deduct from this, the appropriate proportion of the available nil-rate band. The appropriate proportion is the amount of the nil-rate band apportioned to the component concerned in relation to the whole chargeable transfer on death.
Step 3
Add the amount of the charitable legacy that was deducted at step 1 to the amount determined by Step 2, to arrive at the baseline amount.
Summary
Looking at the ever-increasing complexity with the examples above, you can see that some estates might not benefit as much as expected by making a gift to charity within a will. Receiving the right advice on how to structure a will is critical to ensure the requirements are met. Engaging a professional to draft a will up front, can avoid the need to undertake post death variations later.
Having an up to date will, which is reviewed regularly, is an important house-keeping exercise and should form part of the annual review discussion. With more and more clients becoming concerned with IHT planning / mitigation knowing how charitable gifting works to reduce IHT rates applicable is a valuable tool in your armour.
The information provided in this article is not intended to offer advice.
It is based on Quilter's interpretation of the relevant law and is correct at the date shown. While we believe this interpretation to be correct, we cannot guarantee it. Quilter cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.