The new rules for pensions and Inheritance Tax (IHT) are causing many to rethink their financial plans, and some are turning to charity for the answer.
Learn more: Everything we know so far as the government confirms changes to Inheritance Tax and pensions
Put simply, while pensions are currently exempt from IHT, they will be included as part of the estate from April 2027, potentially increasing your IHT bill by a substantial figure.
HMRC offers IHT relief on wealth you leave to a UK-registered charity. So, it’s unsurprising that FTAdviser has reported a 20% increase in the number of pension scheme members leaving their death benefits to charity to reduce their bill.
However, the tax break isn’t available to everyone. Keep reading to discover whether a charitable legacy could help reduce the IHT on your estate.
Gifts to charity are Inheritance Tax-free
If you give money to a loved one during your lifetime and pass away soon after, a portion of that gift could still be liable for IHT.
On the other hand, any money you give to charity is completely IHT-free.
To make a charitable legacy, you can donate:
- A fixed amount
- An item
- What’s left after other gifts have been given out.
These gifts can be made while you are still alive (known as a lifetime gift) or left in your will.
Learn more: Three common myths about Inheritance Tax and gifting to watch out for
Leaving 10% or more to charity could bring your overall Inheritance Tax rate down
If you leave behind 10% or more of your “net estate” – the taxable portion – to charity, then the rest of your wealth might receive a reduced IHT rate of 36% rather than 40%.
Your taxable estate is the value of your belongings and money combined, minus your eligible IHT relief thresholds:
- The nil-rate band – currently frozen at £325,000 until 2031.
- The residence nil-rate band – also frozen at £175,000 until 2031, available to those passing on their main residence to a direct descendant.
So, a person leaving their main home to their child plus their money and belongings could pass on up to £500,000 IHT-free. The remaining value would be taxed at 40%.
The only exception is if the estate is left to a spouse or civil partner, at which point no IHT is due.
Even reducing your IHT rate by just 4% can leave substantially more wealth in the hands of your loved ones.
Example: if your estate above the nil-rate and residence nil-rate bands is valued at £1 million, leaving a gift of £150,000 to a UK-based charity could reduce its IHT liability from £400,000 to £360,000.
The 4% tipping point: Giving more to charity could actually mean your beneficiaries get more too
According to the National Will Register, 1 in 5 charity donors aged 40 and over will leave a gift for charity in their will.
If you’re planning to leave a gift to charity and also possess an estate likely to face a large IHT bill from 2027, altering the size of your charitable contribution might make your estate better off.
This is done by leveraging the 4% tipping point.
If your charitable gift is between 4% and 9.99% of your net estate value, then increasing the size of this gift to 10% (and so reducing the total rate of IHT from 40% to 36%) means you can give more without affecting the rest of your estate. This won’t cost your beneficiaries anything and might even increase their inheritance.
Following the previous example, if you planned to leave 7% of your wealth to charity (which equates to £105,000), after IHT your beneficiaries could inherit £537,000.
However, if you increased your charitable donation to 10%, this would trigger the IHT rate reduction from 40% to 36% on your entire estate, meaning your beneficiaries would instead inherit £544,000.
Note: these are simplified examples of how an IHT bill could fluctuate depending on how much you give to charity. They do not take into account any allowances or reliefs other than the nil-rate bands.
Charitable giving does not always benefit both parties
The conditions under which charitable gifting in estate planning succeeds are narrow; not everyone can benefit from the rule.
For instance, if you were to choose not to leave a gift to charity in your will from your £1.5 million estate, your loved ones would receive £600,000 between them – £54,000 more than if you fully leveraged the charitable gifting rule.
Ultimately, whether the rule suits your financial plan is entirely based on your personal circumstances, beliefs, and objectives.
If you were always intending to leave a gift to charity valued somewhere between 4% and 9.99% of your estate, this strategy may be to your benefit. If not, then giving to charity with the sole purpose of reducing IHT might not be worth it.
Discover alternative ways to reduce your estate’s IHT liability with your Milsted Langdon financial planner
Charitable giving isn’t the only way you can reduce your IHT bill – strategies like lifetime gifting, trusts, and reliefs and exemptions can all help mitigate your estate’s tax liability.
We’ve covered these topics extensively in previous articles, which you can find below:
- A refresher on Inheritance Tax as 71% of UK adults don’t understand how it works
- Could placing life insurance in a trust help your loved ones reduce Inheritance Tax?
- How equity release could support your estate planning goals
If you’d like to learn more about how we can help you reduce your estate’s IHT liability using charitable gifting or any of the above strategies, please get in touch or email us at advice@mlifa.co.uk for more information.
Please note
This article is for general information only and does not constitute advice. The information is aimed at individuals only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate estate planning, tax planning, trusts, or will writing.