Basically, we have four choices as to what to do with our money – we can spend it, save it, invest it or give it away and quite often it can be a combination of all these.
As a result of the pandemic many charitable organisations are struggling with funding their work, so this blog focuses on giving money away and the options that are available to support charities and the tax benefits of doing this, both during lifetime (active giving) and via a Will (passive giving).
Charitable giving during lifetime
A recent survey conducted by the Personal Finance Society showed that less than a quarter of clients of financial advisers made donations to charity. I believe this may have something to do with the fact that clients of advisers want to put their family first. Furthermore, they may also be uncertain as to whether they can afford to make charitable gifts and are also likely to be unaware of the benefits of charitable giving, perhaps seeing it as something for the “rich few.”
As well as the pleasure and happiness that can often be derived from charitable giving, the tax benefits are generous. If someone donates £100 to a charity and they are a taxpayer, Gift Aid increases that to £125. The charity can reclaim £25 because the donor (person making the gift) is regarded as having basic rate tax deducted on the gross amount.
If the donor is a 40% taxpayer, they can reclaim 20% tax relief through their tax return. On a donation of £125 this would be £25. Furthermore, charitable donations can be used to reclaim the personal allowance for individuals whose taxable income exceeds £100,000. The income tax personal allowance reduces by £1 for every £2 over £100,000. However, Gift Aid donations can restore the personal allowance with an effective tax relief of 60%.
To make a Gift Aid donation you must pay at least as much Income Tax and/or Capital Gains Tax as the amount reclaimed by the charity. The source of the gift can be capital and therefore doesn’t have to be natural income. Also, assets such as qualifying shares can be gifted to a charity and any capital gains will not be taxed.
Where there is a desire to make “significant” gifts, there may be a disconnect between being able to afford to make the gift (and benefiting from the tax relief) and choosing a charity or chosen project. To address this potential barrier there is a structure where a gift can be made into a donor advised fund. This type of structure separates out the securing of the tax relief from the identification of an appropriate project. At the point the gift (or series of gifts) is made into the fund the tax benefits are received but the donor can then decide at what point grants are paid out of the fund to their chosen charities or project.
This structure is likely to appeal to individuals or couples who have assets in excess of £5m and who perhaps don’t want to have the hassle and cost of setting up their own charitable foundation.
Although this type of structure will only be relevant to a small minority the tax benefits of making gifts is available to the majority. Furthermore, there is an unlimited exemption from Inheritance Tax on any gifts to a charity made during lifetime.
Charitable giving via a Will
In order to encourage charitable giving and philanthropy gifts to charity via a Will are exempt from Inheritance Tax (IHT) regardless of the size of the gift. Furthermore, a reduced rate of IHT applies where a deceased leaves 10% or more of their net chargeable estate to charity. The net chargeable estate is what remains after the deduction of available IHT free allowances (the nil rate and residence nil rate bands). In such cases the usual 40% rate will be reduced by 10% to 36%.
As to how this works in practice, I will use a simple example of a surviving spouse’s estate which is worth £1 million, with a gift of £50,000 being left to a charity and the rest to the children. After the combined nil rate bands of £650,000 are deducted this leaves a baseline amount of £350,000. The £50,000 gift exceeds 10% of the baseline amount so the reduced tax rate of 36% will apply to the part of the estate passing to the children.
As a result, the IHT liability is reduced by £12,000 to £108,000 (36% of £300,000). The calculation can be more complexed where there are also assets held in trust, but it is a tax planning opportunity which can often get overlooked.
In conclusion, financial planning can help an individual or couple to firstly establish whether they are likely to be able to afford to give some of their money away during their lifetime either to support their family and/or their favourite charities without it derailing their own lifestyle.
Secondly financial planning can also help to decide whether there is a desire to leave a charitable legacy because in both scenarios there are multiple benefits in doing this.