Simple gift rule that reduces 40% inheritance tax rate on estate

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Inheritance tax (IHT) is applied to the estate of someone who has passed away, such as assets, property and money, and can often leave families and loved ones with a sizeable bill to pay. However, if managed strategically, people can legally lower the tax rate and pass on a lot more to friends and relatives.

Currently, the single person’s inheritance tax threshold is £325,000 and is referred to as the nil-rate threshold. Tax is only ever paid if the value of the estate exceeds this figure, after which a 40 percent tax is applied.

While there are certain ways to boost the nil-rate threshold through things like gifting and marriage [express link], there is also a way to reduce the 40 percent tax rate on the qualifying estate, and this is through a charitable donation.

Mark Greer, managing director of philanthropy services at the Charities Aid Foundation, said: “A gift to a UK charity is free from inheritance tax, meaning that the money is ‘removed’ from the value of a donor’s estate before tax is calculated.”

In addition to the donation being tax-free, Mr Greer said that gifts to charities can reduce the amount of inheritance tax paid on the rest of the estate – but the gift must amount to at least 10 percent of the estate.

He explained: “If 10 percent or more of the estate is gifted to charity, then the rate of inheritance tax paid on the rest of the estate is reduced from 40 percent to 36 percent. Gifts in Wills can therefore make a difference to the causes that donors care about the most, whilst having a positive impact on the remainder of their estate.”

Legacy donations are incredibly important to charities as according to Free Wills Month, most UK charities depend on legacies for up to half of their income.

Mr Greer continued: “For many people, leaving money to charity in a Will can also be a way to give a far more substantial donation than they ever could in their lifetime.”

For instance, he said: “A £100,000 gift to charity from a £1million estate only ‘costs’ the beneficiaries of the estate £24,000.”

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Jeannie Boyle, director and chartered financial planner at EQ Investors added: “The reduction only applies to gifts made through your will, not whilst you are alive.

“This means that a person intending to gift four percent of their estate to charity could increase this to 10 percent without reducing the amount left to their other beneficiaries.”

Using up other gift allowances while still alive can be another effective way of sharing wealth and in turn, leaving a smaller bill for beneficiaries.

There are several allowances for gifts which are automatically exempt from inheritance tax, including a yearly gift of £3,000. This can be carried forward one tax year if unused.

Ms Boyle said people can also make unlimited small gifts of £250, however, she noted: “You cannot have used any of the other exemptions on the same person.”

Gifts between spouses or for the maintenance of children, or dependent relatives are also free from inheritance tax, according to Ms Boyle. She said: “You might be contributing to the care costs of a parent, or helping a child cover their rent at university.”

Gifts to people getting married are also exempt up to a certain threshold depending on the person. This includes:

  • A gift worth up to £5,000 for the person’s child
  • £2,500 for a grandchild or greatgrandchild
  • £1,000 for anyone else.

People can also make gifts from surplus income without impacting inheritance tax, but certain conditions must be met.

Ms Boyle said: “This is almost exactly what it says on the tin. These gifts must be from income, not capital, and cannot impact your lifestyle. You can’t use your income for gifts and then draw on assets to fund life.

“These gifts need to be habitual, which normally means they happen periodically. This does not always have to mean every month, or year on the same date, or indeed the same amount every time.”

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