The little-known way to save more than £40,000 on your inheritance tax bill by making the most of giving to charity

If you’re worried your family may face a large inheritance tax bill after you die, giving more money to your favourite charity could be the key to cutting it, new calculations show.

This is because charitable donations can trigger a little-known rule that lowers the rate of inheritance tax families have to pay.

Marianna Hunt, of investment group Fidelity, says: ‘Giving more money to charity can be a powerful way of supporting the causes you care about while potentially reducing the tax paid on your estate.’

The number of families that are caught in the inheritance tax net is expected to spike in the coming years due to a crucial change in the rules. From April 2027, pensions will be counted as part of estates and liable to death duties for the first time. Thinktank the Institute for Fiscal Studies (IFS) predicts that by 2032 one in eight people will trigger an IHT bill on their own death or on the subsequent death of their spouse or civil partner.

Ian Dyall, head of estate planning at wealth management firm Evelyn Partners, says the change will leave families with a ‘super-sized tax burden’. ‘The scope of IHT will increase dramatically from next April,’ he says.

‘More families will become subject to IHT and estates that are already facing an IHT bill could be looking at an even greater one.’

It is therefore more important than ever to plan ahead if you want to spare your loved ones from a large tax bill. So how do the rules work? And how much do you need to give to charity for the gift to lower your inheritance tax bill?

Generous gifts can leave your family with more

Everyone has a £325,000 allowance – called the nil-rate band – that can be passed on free of inheritance tax (IHT). There is an additional tax-free allowance of £175,000 specifically for when the family home is left to ‘direct descendants’ such as children or grandchildren.

Any wealth above this, including the value of your home, is subject to a 40 per cent rate.

Giving to charity is one way to reduce the amount that is handed to the taxman because any gifts you make are exempt from IHT.

Importantly, if the gift is worth at least 10 per cent of the estate’s ‘baseline value’, then inheritance tax falls from a rate of 40 to 36 per cent.

HMRC works out the baseline by taking the estate’s value after debts are paid and relevant reliefs have been accounted for, such as those for business or agricultural assets.

The taxman then deducts the nil-rate band – the amount everyone can pass free of IHT. (The residence nil-rate band is not counted, however).

For example, if someone had £1million to pass on, their family could receive £325,000 under the nil-rate band. This means the baseline value of the estate is the remaining £675,000.

In this instance, the gift to charity would have to be worth at least £67,500 for the inheritance tax rate to fall – 10 per cent of the baseline value.

Hunt, of Fidelity, says that although many people know that gifts to charity are exempt from IHT, many fewer know about the 10 per cent rule.

‘But this little known rule can be very valuable – it can save more than £40,000 on IHT on a £1million estate,’ she adds. 

To illustrate how powerful this can be, she has compared what happens when an estate worth £1million, including a property and pension, is left to a family with and without charitable donations.

The example assumes the estate qualifies for the full £175,000 residence nil-rate band, in addition to the £325,000 nil-rate band.

This means that a person with £1million could pass on £500,000 tax free. If no charitable gift is made, the family would owe 40 per cent on the remaining £500,000 – leaving them with a £200,000 tax bill. This means they receive £800,000 as an inheritance.

To qualify for the lower rate of inheritance tax, they must give at least £67,500 – 10 per cent of that baseline– to charity.

Say, for example, a £40,000 gift is made. The taxable part of the estate would be £460,000 so the family would owe £184,000 in tax and receive £776,000 as an inheritance.

The IHT bill would be £16,000 lower than if no gift were made –but the family also receives £24,000 less. If the charitable gift is increased to £67,500, the family only pays tax at 36 per cent instead of 40 per cent. With this gift, the taxable part of the estate falls to £432,500, meaning the family owes an IHT bill of £155,700. This is less than when a smaller gift was made.

In this scenario the charity receives £27,500 more, and the family also receives £800 more – £776,800 rather than £776,000.

However, they still receive less than if no gift was made at all.

Getting it right

Hunt explains that these figures are just an illustration – every family’s calculation will be slightly different depending on the debts owed and expenses. Where a spouse has already died, they will leave their nil-rate band to a surviving partner. This means a married couple could pass up to £1million to their children without paying any IHT.

She also points out that it is impossible to know exactly what your estate will be worth at the time of your death when you are writing your will.

‘If you specify a fixed charitable donation in your will based on the value of your estate today, but your estate grows significantly before your death, the donation could fall short of the 10 per cent threshold,’ she says.

‘Rather than specifying a fixed amount, you could instead ask a solicitor to include some wording in your will that ensures your charitable donation meets the 10 per cent threshold, even if the value of your estate changes.’

Using a qualified solicitor or will writer who is an expert on these matters will help you to get this right. If you are planning to leave a charitable gift, you may be able to get the will drawn up for free – contact one of the charities you’re planning to leave a legacy to and ask whether it offers a free will-writing service.

This could save you around £500 now on a pair of mirror wills for a couple. But beware, these wills tend to be one-size-fits-all and may not be suitable for your family.

Other ways to slash IHT bill

Hunt adds that, as well as giving to charity, families should explore other ways to reduce IHT.

Gifts given more than seven years before you die are generally exempt from tax, while other exemptions are available too.

You can give away £3,000 a year without it being subject to IHT and a parent can give £5,000 as a wedding gift without paying tax, she explains. Regular gifts from surplus income can also be exempt if they do not affect your quality of life.

‘Each has its own rules, so it’s important to look into the details,’ she says.

Read our guide to protecting your wealth from inheritance tax