This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
It might feel strange to talk about giving during a cost of living crisis in 2023. After all, wouldn’t your money be best spent on keeping your household afloat? Yet giving has many benefits. Not only is it a moral act in itself, but it forms part of our human nature and gives a sense of purpose and belonging. It brings a sense of reward, fulfilment and satisfaction as we set an example for others. More self-interestedly, however, giving to charity can help lower your tax bill.
Yet what is the best way to give to charity from a financial planning perspective? In this article, our Burnley financial planners offer some thoughts on this important subject. We hope this content is useful to you and please get in touch if you’d like to discuss your own financial plan with us over a free, no-commitment consultation.
Extend your tax threshold
You have likely heard of Gift Aid which allows registered charities to claim 25p for every £1 you donate. This involves filling out a form and you can cover all donations from the last 4 years. Your donations cannot be higher than 4 times the tax you paid in a given tax year. However, a little-known extra benefit of Gift Aid is that your basic and higher rate tax bands are extended by the gross charitable donation. In effect, this allows you to increase the portion of your income to be taxed at a lower rate. For instance, suppose you pay the higher rate on your income. You make a £100 donation to a registered charity via Gift Aid, which extends your basic rate band by £125. This means that £125 of income that would have been taxed at 40% is now taxed at 20%.
For higher earners, Gift Aid can even further tax benefits. Those earning between £100,000 – £125,140 typically see their £12,570 tax-free Personal Allowance reduce by £1 for every £2 earned above £100,000. However, for every £2 of gross Gift Aid donations above this figure, £1 of your Personal Allowance is restored. This can help to mitigate an “effective tax rate” of 60% on income within the £100,000 – £125,140 range.
The 60% “effective rate” can be obscure and difficult to understand. Yet an example might help to show how it works. In 2022-23, every £100 you earn over £100,000 is taxed at 40% (the higher rate), leading to a £40 bill. Moreover, £20 of your Personal Allowance is taken away. Add this together and you get a 60% effective rate of tax (£60). However, suppose you make a £100 gift to charity instead, via Gift Aid. This “extends” your basic rate threshold to £100,100 (rather than £100,000), increasing the income which is taxed at 20%, not 40%. Also, you get to keep the £20 that would have gone to the government (via lost Personal Allowance).
In conclusion, by making a £100 donation you have “lost” £40 – not £60, had you kept it and lost money to tax. Bear in mind that the threshold for the 45% additional rate is set to reduce to £125,140 on 6 April 2023, down from the current £150,000 threshold.
Reduce your inheritance tax bill
In 2022-23, an inheritance tax (IHT) rate of 40% is typically applied to the value of an estate over £325,000 when the owner dies. However, one idea to reduce a future IHT bill is to leave 10% to charity, which lowers the IHT rate from 40% to 36%. For example, suppose someone dies and leaves a £400,000 estate to his children. He did not own his own home and was not married. Here a 40% IHT rate would result in a bill of £160,000, leaving just £240,000 between the children. However, imagine he gave £20,000 to charity as part of his will. Now, the 40% rate is applied to the remaining £380,000 value in his estate, leading to a £152,000 IHT bill. £8,000 is thus saved on IHT, with £228,000 left for the children (who receive £12,000 less than had he not made the donation).
As such, charitable giving when planning an estate is not always useful to maximise the amount of wealth you want to leave to family members after your death. However, the IHT rules help to encourage charitable giving. If your goal is to reduce an IHT bill and put some of your wealth into noble causes, then this might be an effective strategy to explore with a financial adviser. Another route to consider is setting up a charitable trust (e.g. for the purpose of preventing or relieving poverty). Here, your gifts into the trust are exempt from IHT and can also be done via Gift Aid, thus benefitting you as the settlor as well as the charitable trust (which can claim back).
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
E: info@elmfieldfp.co.uk
