Customer query:
“I am thinking about how I can make bequests from my estate to my favourite charities and wondered if I can gift some of my pension in this way and whether or not this makes sense, given my estate might have to pay inheritance tax. I’m interested in the pluses and minuses around giving money to charity on death from my pension”.
There are certainly good inheritance tax breaks on offer if you decide to leave money to charity when you die, so let’s cover that off first.
Key points on inheritance tax
If you leave 10% or more of your estate to charity, the estate will benefit from a lower rate of inheritance tax. The tax rate is usually 40%, but this will be cut to 36% if you meet the criteria.
When working out your will, it’s important to note that you won’t know exactly what your estate size will be when you die. For this reason, it’s usually wise when leaving gifts to charity in a will to state it as a percentage of the estate, rather than a lump sum in monetary terms. That’s particularly the case if you want to meet the 10% threshold for qualifying for reduced inheritance tax.
It’s also worth noting that your donation to charity is only 10% of the estate that will be liable for inheritance tax – you can deduct any nil rate bands you’re eligible for before calculating this number.
For example, if you had an estate worth £1 million and you were eligible for the standard nil rate band of £325,000 you would only need to leave 10% of £675,000 (£67,500) to qualify for the lower IHT rate.
Gifting money from a pension
Your pension already sits outside your estate for IHT purposes. You can leave money from your pension directly to a charity via a ‘charity lump sum death benefit’: a sum of money paid to a registered charity on death, that will also be tax-free.
There are some rules around this though: the charity must be nominated by the person who died (in this case, yourself) rather than by your executor, for example.
The second, potentially bigger hurdle, is that the individual can’t have any dependents. For the purposes of this rule, a dependent is a spouse, civil partner, a child under the age of 23, and some co-habiting partners. So, it will depend on your specific circumstances whether that could apply to you.
Gifting a lump sum from a pension
Another alternative is to leave a lump sum from your pension to a charity on your death, although this is potentially less tax efficient than the example above.
Under current rules, if you died before the age of 75 this lump sum payment would be free of tax if it was paid from funds you had previously allocated to drawdown but not used in your lifetime. If the lump sum was from funds you had not yet accessed, this would also be tax free – as long as you have sufficient unused lifetime allowance. However, if you died after the age of 75, or had unused funds above the lifetime allowance on death before age 75, it would face a 45% tax charge.
Giving money from a pension before death
One other option worth considering is donating money to charity from your pension while you’re alive. Clearly this involves some calculations on whether you can afford to gift money when you’re still alive, as you don’t want to risk depleting your assets before you die.
You’ll also need to be taking benefits from your pension, so be over the age of 55. But if so, you could make use of payroll giving to donate money to charity.
This is where you make a payment to charity from your gross income and the income tax you would have paid goes to the charity instead – which if you’re a higher or additional rate taxpayer can really boost your donation. However, this approach depends on your pension provider being able to facilitate it, and not all can.
Our team are on hand to support you with any query that you may have so feel free to get in touch.
Laura Suter | Head of Personal Finance