Can the net estate be increase by giving money away?

Reduced IHT rate

Since 2012, if someone leaves 10% or more of their estate to charity the inheritance tax (IHT) rate payable is reduced from 40% to 36% (assuming they’re worth enough for IHT to be payable).

This sounds a simple concept but it’s not; there are a number of wrinkles to contend with. However, on the plus side there’s a hidden tax break available for the taking.

10% of what?

The 10% the individual needs to give to charity in the will doesn’t necessarily have to relate to the whole estate. For the purpose of working out if the reduced IHT rate applies, the estate is divided into three components and the 36% tax applies to any of these where 10% or more of it is donated. The components are:

1. Survivorship assets. Property owned jointly with others and which automatically passes to them when the individual dies.
2. Settled property. This refers to the part of the estate, if any, that is held in trust.
3. General. Everything else. Charitable bequests are treated as coming from this first.

Example. Ira’s estate is worth £1.1 million. It consists of shares in her company worth £400,000, a joint share in a home worth £450,000, plus investments and personal items valued at £250,000. Ira dies in October 2021. Her will leaves the company shares to her children, £35,000 to various charities and the remainder to her partner, Jay.

Calculations

While the £35,000 bequest is less than 10% of her estate as a whole, the donation must be compared with the components in her estate to determine if the 10% benchmark is met.

Survivorship component. Home £450,000 less pro rata proportion of the nil rate band (NRB, £325,000) £185,715 = £264,285.

General component. £650,000 (£400,000 + £250,000) less business property relief: £400,000, less proportion of NRB £139,285 = £110,715.

The donation of £35,000 is first compared to the baseline of £110,715. As it’s greater than 10%, the 36% rate of IHT applies to the general component. However, it doesn’t past the test for the survivorship component.

Merging components

Ira’s executors and beneficiaries can elect to merge the two components of her estate and compare the charitable gift with the total. If it exceeds 10% of this, the 36% IHT rate will apply to both components. In our example the £35,000 wouldn’t quite be enough to achieve this.

Jay and the other beneficiaries can vary Ira’s will to increase the donation to charity by £2,500 and elect to merge the components. The charities will be better off by £2,500 as a result. Plus, the IHT rate on the whole estate is reduced to 36% saving £10,000 and leaving Jay better off to the tune of £7,500 (£10,000 - £2,500).