Charity avoids a taxing legacy

Giving to worthy causes can help safeguard an inheritance

'BUT you were always a good man of business, Jacob," faltered Scrooge, who now began to apply this to himself.

"Business!" cried the Ghost, wringing its hands again. "Mankind was my business; charity, mercy, forbearance, and benevolence, were, all, my business. The deals of my trade were but a drop of water in the comprehensive ocean of my business!"

THE words are from A Christmas Carol by Charles Dickens but perhaps our Chancellor, George Osborne, also had them in mind when he announced his incentive aimed at encouraging people to bequeath money to charity in their wills.

The Chancellor hopes it will become the "new norm" in the UK for people to leave at least 10 per cent of their estate on death to charity and indeed has set up a funding appeal whose initial target has been set at 300 million.

But Osborne's appeal is not just aimed at "the rich" as it would have been 20 years ago. Increases in personal wealth, largely fuelled by property values, coupled with a failure to raise the inheritance tax (IHT) threshold in tandem, means that millions of semi-prosperous "baby boomers" from the post-war period now face the prospect of IHT impacting on the wealth they hope to pass on to their families. As a result of the Chancellor's initiative, bequests to charity may in the future play a bigger role in inheritance tax planning.

Most people who leave money to charity are driven - wholly or partly - by altruistic reasons; quite simply they believe in the work of the recipient organisation and derive some satisfaction from the thought of making a contribution to help this continue after they have gone.

But there are also practical reasons for giving to charity. When a person dies, IHT is charged on the value of a person's assets on death. Whilst every individual has a tax-free band (currently 325,000), the value of any estate in excess of the tax-free band may be taxed at 40 percent. A legacy to charity in your will, however, is free from IHT and so may reduce the IHT liability of your estate.

How people react does, of course, depend on individual circumstances. It is not unusual for those without children to leave part of their wealth to charity. Some may simply struggle to think of a relative or close friend who they want to benefit from their wealth or may take the view that any next of kin are already sufficiently well off. Charitable bequests are likely to feature higher on the agenda for people in these circumstances.

However, from 6 April next year, all who leave money to charity will be able to further alleviate any tax burden on their estate.The Osborne proposals will mean that when someone leaves 10 per cent or more of his or her net estate to charity, the IHT charged on the remainder will be reduced from 40 per cent to 36 per cent.

Despite this, some grown-up children may take the view that charity begins at home and disapprove of parents giving away a substantial part of "their" inheritance to good causes. Therefore, if thinking about making a bequest to charity, it should be realised that no matter what a will states, a spouse and children have certain automatic legal rights to part of a "moveable" estate (which includes cash and investments but not housing).

Meanwhile, IHT relief is allowable on donations made during one's lifetime and not just on bequests after death - so wealthy individuals who pour large sums into charitable causes during their careers are effectively reducing the liability of their estate on death to tax.

Some people intending to leave a significant capital lump sum to charity decide to set up a charitable trust or foundation for lasting purposes. The advantage, in Scotland, is that a trust allows the donor to exercise a measure of control over how the funds will be applied in the future. Trusts are often grant-making vehicles and this could include bursaries, scholarships or regular donations of trust income to charities meeting selected criteria.

Assets gifted to the trust by its donor are free of capital gains and inheritance tax. Gifts of income can also be made by various tax efficient methods. One advantage of the trust is that income and gains it makes will generally be exempt from income, corporation and capital gains tax.

Finally, when an individual dies with a pension fund in "drawdown", the balance may be paid as a lump sum to any beneficiaries. The tax charge on this is fixed at 55 per cent, but again, if left to charity the money is free of tax. Therefore, people trying to balance bequests to their offspring and to charity may consider it more appropriate to take an IHT "hit" of 40 per cent on their conventional estate rather than 55 per cent on what remains of their pension fund, especially if the latter is substantial.

• Peter Shand is an associate with Murray Beith Murray, based in Edinburgh