Charitable Gifts as part of estate planning

CHARITABLE GIFTS AS PART OF ESTATE PLANNING 

By Barbara Gardener 

The topic of charitable gifting is a deliberate choice in the run up to Christmas. Charities have also been in the news lately, not least because of some changes in the law applicable to charities in the shape of the Charities Act 2022.

Charitable gifting during the cost of living crisis

A recent consumer benchmarking survey conducted by Remember A Charity, found that 19% of respondents said they had included a charity in their Will, and a further 10% were preparing to do so. Apparently, fewer than one in ten respondents rejected the idea altogether.

The 2021 Census statistics revealed the greatest number of people in the UK are now in the 65+ age bracket than ever before. This age group now accounts for 18.6% of the UK population, compared with 16.4% a decade ago.

Although most people would usually wish to leave their estate to the next generation, longer life expectancy has had a knock-on effect on the age at which people inherit from their parents. Indeed, those children may well already be in the later stage of life and with their own accumulated wealth. There are also more people who do not have children. This may explain why more elderly people are increasingly likely to choose to include a charitable gift in their Will, or indeed make lifetime gifts to charities.

There is also evidence that philanthropy as part of wealth planning has become increasingly important to high-net-worth individuals – HNWIs. For example, according to private wealth law firm Boodle Hatfield, HNWIs have established 170 charitable family foundations in the UK since 2012.

Whilst in the UK  HNWIs  are defined for the purpose of Financial Promotion exemption as individuals who certify that they have earned at least £100,000 in the previous year or hold net assets of at least £250,000, the US definition used in the  below mentioned Capgemini report refers  to those with at least $1m of liquid assets.

Globally, the number of HNWIs has grown to over 22m according to the Capgemini 2022 World Wealth Report. In 2021, there were 609,400 HNWIs in the UK.

A frequent motivation for HNWIs to venture into philanthropy is to leave a legacy (following in the footsteps of the super rich like Warren Buffet or Bill Gates) as well as, of course, the various tax reliefs. Let's start with a reminder of the various tax reliefs for charitable gifts in the UK. 

Tax reliefs available to charitable donors

Charitable giving has been encouraged for some time by means of a variety of tax reliefs available to donors. These reliefs benefit charities indirectly, since the relief is likely to have the effect of increasing the total amount received by the charity that can be applied for charitable purposes. There are reliefs in respect of income tax, capital gains tax (CGT) and inheritance tax (IHT). 

Income tax reliefs

(i) Gift Aid

• Individuals who are higher/additional rate taxpayers can claim tax relief on the difference between basic and higher/additional rates of income tax for cash gifts made to charities under the Gift Aid scheme. These donors can claim relief against income tax or capital gains tax. 

• The charity can reclaim basic rate tax on donations received under the Gift Aid scheme from individuals. So, in effect, each such cash gift is worth 25% more to the charity. 

 (ii) Payroll deduction scheme

This scheme allows an employee to make gifts to a charity by having sums deducted by their employer from their salary before calculating the amount of tax due on the salary. The payroll deduction scheme offers considerable scope for charitable fund raising, provided both the employer and employee are in agreement. These schemes are often popular for raising funds for local charities, but the cost of administration may put off some smaller employers.

CGT and charitable gifts

It must be remembered that Gift Aid only provides tax relief in respect of gifts of cash. A gift of an asset to a charity will however qualify for CGT relief – effectively no CGT arises on a gift to a charity. 

IHT and charitable gifts

IHT exemption for all charitable gifs

First, there is a general unlimited exemption from IHT on any gifts to a charity made during lifetime or by Will. 

However, it must be remembered that the Gift Aid provisions do not apply to gifts by Will, so no income tax relief will apply as is the case for lifetime gifts. As a matter of planning, it may sometimes be recommended that the testator makes the legacy to an individual and not to a charity, while expressing a wish that the beneficiary should make a gift to a charity, and the legatee then makes the gift to charity which qualifies for Gift Aid relief. Of course, this would only be relevant where the testator can rely on the particular beneficiary willing to carry out the testator’s wishes. The advantage would be that the charity will receive an additional benefit and there will be an income tax benefit for the beneficiary of the Will, particularly if they are a higher/additional rate taxpayer, as the grossed-up donation is fully relievable at the difference between basic rate tax and the higher/additional rate of tax. 

Even where there is no charitable legacy in the Will and/or the deceased did not contemplate making such a gift, if a beneficiary of a Will intends to make a charitable donation, a deed of variation of the deceased's Will could be carried out so that the legacy itself is treated (subject to it being made within two years of death) as made by the deceased under section 142 IHTA 1984 for IHT purposes. Such a variation would certainly make sense if the legacy was subject to IHT.

Reduced IHT rate if charitable legacies are at least 10% of estate

For deaths occurring on or after 6 April 2012, where an estate includes a qualifying charitable legacy of 10% or more of the net estate, the remaining taxable estate will benefit from a 36% rate of IHT, rather than the normal 40% rate. For these purposes, the ‘net estate’ is the value of the estate after taking into account the available nil rate band (NRB) (including any transferable NRB), IHT exemptions (such as the spouse/civil partner exemption) and IHT reliefs (such as business relief) but includes the value of the charitable legacy itself. 

The reduced rate does not have to just apply to assets transferred under the deceased’s Will and can also apply to other assets on which IHT is payable on death. 

 When calculating the availability of the reduced rate the estate is divided into three ‘component’ elements:

 Jointly owned assets which pass by survivorship or similar provision (the ‘survivorship component’). These would be assets such as bank accounts or property owned as joint tenants (as opposed to property owned jointly as tenants in common which will pass under the terms of a Will). 

• Trust assets in which the deceased had a qualifying life interest or right to income immediately before death (the ‘settled property component’). These would be arrangements such as pre-Finance Act 2006 interest in possession trusts and immediate post-death interest trusts.

• All other assets in the estate, including the free estate, but not including property which the deceased gave away but reserved a benefit in it for IHT purposes (the ‘general component’). 

The total value of charitable legacies will be compared with the baseline amount to determine whether the ‘component’ of the estate qualifies for the reduced IHT rate. The reduced rate can apply to either individual components or they can be merged and the reduced rate applied across the merged components (if the charitable legacy is 10% or greater of the value of the merged components). 

Some people will simply want to use the charitable legacy route to reduce the IHT rate on the remainder of the estate, i.e. to limit the charitable legacy to the required 10%. In such a case, special wording may be included in the Will to ensure that this happens. In many cases, however, in particular where the testator has no children and no spouse or civil partner, they may want to leave a larger portion of their estate to a charity. If you are an adviser and are looking at a client’s Will, or advising them on how to structure their Will, while it may be apparent that the reduced rate will apply, for example where they intend to leave a third of their estate to charities and the rest to nephews and nieces, when it comes to working out the potential IHT liability on the estate things may not be quite so straightforward (please see below re partly exempt transfers).

 If you are struggling with words for a Will clause to guarantee the 10% reduction in the IHT rate, here is suggested wording from STEP: 

1.1 I give [name of charity] such a sum as together with any other gifts to charity made under my will or any codicil shall constitute a donated amount equal to ten per cent (10%) of the baseline amount in relation to the general component of my estate.

1.2 If relief under Schedule 1A Inheritance Tax Act 1984 (IHTA) shall have been abolished at the time of my death or if inheritance tax shall have been abolished at that time this legacy shall instead of the amount specified in clause 1.1 above be a sum equal to [ ] per cent ([ ]%) of the residue of my estate. 

Of course, further clauses may be added to clarify how such a legacy should be applied.

A legacy of a fixed sum or a legacy of residue?

There is a valid argument in favour of leaving a specific legacy rather than a share of the residue of one’s estate to a charity. The problem is in calculating the IHT due on gifts that are partly exempt. If a part of the residue is left to a charity and part to an individual, we have the task of calculating tax on ‘partly exempt transfers’ and legend has it there are only two people in this country who know how to do this. This is because there are very complex rules in the legislation and, indeed, case law on how the tax should be borne where the Will provisions are not clear enough. What is essential is that the Will should state whether the intended beneficiaries should receive their specified shares or amounts of the residue "before" or "after" tax, and this frequently does not happen. Needless to say, things will get even more complicated where the estate includes trust interests and / or property qualifying for business or agricultural property relief. Professional assistance should always be obtained in such a case. The easier alternative would, of course, be to leave a fixed sum to a charity/ies or to a charitable trust. 

An outright legacy or a charitable trust? 

If the testator knows exactly which charities they want to benefit, that would be the easier way to leave a legacy. In such a case, all that would be required is to verify that the intended beneficiaries are indeed qualifying charities. Often legacies are left to schools or clubs or foreign institutions and not all of them will qualify as a charity for the purpose of the 10% IHT reduction. 

If the client is not totally certain about which particular charities should benefit outright, the option would be to include a charitable trust in the Will. We will look at the requirements for such a trust to qualify as a charitable trust next month. 

Including charities as beneficiaries of a discretionary Will trust 

An "ordinary" discretionary trust, which includes, say, family members as well as charities as potential beneficiaries, will not qualify as a charitable legacy for the purposes of the 10% IHT rate reduction. However, it should be remembered that any appointments made by the trustees within two years after the death of the testator are "read back" into the Will, so, as long as there are advancements to qualifying charities made by the trustees within those two years, the same result will be achieved as if there were outright charitable legacies included in the Will.  

Comment 

In the current economic climate and especially given the demographics, when advising on estate planning the question of charitable giving must not be left out, especially when dealing with unmarried (not civil partnered) clients and those without children/grandchildren  where a testator is not able to benefit from the various reliefs and exemptions reserved for married people/civil partnerships with children (namely the spouse/civil partner exemption, the transferable nil rate band and the residence nil rate band). It may even be that people in this category are more likely to make charitable legacies. 

Over the next couple of months, we will look in more detail at the current law governing charities and how to set up a charitable trust as well as choosing suitable investments for charities.