Further Examples of Reducing IHT

Example 1 - Only one estate component

Robert died on 17 June 2012 leaving an estate valued at £750,000 after the deduction of liabilities. He leaves £50,000 to Merchant Taylors' School in his will.

Step 1 - deduct the £50,000 MTS donation from £750,000 (the net estate). This leaves a figure of £700,000.

Step 2 - deduct £325,000 (Inheritance Tax nil rate band) from £700,000. This leaves a figure of £375,000.

Step 3 - add £50,000 (the value of the MTS donation) back to £375,000. This gives a figure of £425,000 - the ‘baseline amount’.

10 per cent of the estate of £425,000 is £42,500. This estate qualifies for the reduced rate of Inheritance Tax because the charitable donation of £50,000 is more than 10 per cent of the ‘baseline amount’.

The Inheritance Tax payable will be £135,000 (36% of £375,000) compared to £150,000 (40% of £375,000) if Inheritance Tax was paid at the full rate.

Example 2 - One estate component with gifts made in the seven years before the death

James died on 17 July 2012 leaving an estate valued at £750,000 after the deduction of liabilities. He leaves £50,000 to Merchant Taylors' School in his will. He had given £150,000 to his daughter in April 2008. Because this gift had been made less than seven years before he died it must be taken into account in working out the Inheritance Tax payable on James's estate.

Step 1 - deduct the £50,000 MTS donation from £750,000 (the net estate). This gives a figure of £700,000.

Step 2 - deduct £150,000 (the gift to his daughter) from £325,000 (the Inheritance Tax nil rate band). This gives a figure of £175,000.

Step 3 - deduct £175,000 (step 2) from £700,000 (step 1). This gives a figure of £525,000.

Step 4 - add £50,000 (the value of the MTS donation) back to £525,000. This gives a figure of £575,000 - the ’baseline amount’.

10 per cent of the estate of £575,000 is £57,500. This estate doesn’t qualify for the reduced rate of Inheritance Tax because the charitable donation of £50,000 is less than 10 per cent of the baseline amount

The beneficiaries of this estate could choose to increase the charitable donation by another £7,500 by making an Instrument of Variation so that the 10 per cent test is passed. This would mean Inheritance Tax could be paid at the reduced rate of £186,300 rather than £210,000. This is a tax saving of £23,700, which will cover the additional payment to charity.

Example 3 - Two or more estate components

Elizabeth died on 17 May 2012 leaving assets owned personally of £750,000 after the deduction of liabilities. Her will stated that she wanted to leave 10 per cent of her assets to Merchant Taylors' School. She held a joint bank account with her son Andrew, which had a balance of £60,000 at death. Both contributed equally to the account so her estate also had joint property assets passing by survivorship of £30,000.

The estate therefore contains a survivorship and a general component. The charity donation in the general component is £75,000.

General component

Step 1 - deduct the donation to MTS (£75,000) from the value of the general component (£750,000). This gives a figure of £675,000.

Step 2 - add the £30,000 survivorship component figure to £675,000. This gives a figure of £705,000.

Step 3 - apportion the nil rate band between the two components. Divide 675,000 (step 1) by £705,000 (step 2) and multiply by £325,000 (Inheritance Tax nil rate band). This gives a figure of £311,170.

Step 4 - deduct £311,170 (step 3) from £675,000 (step 1). This gives a figure £363,830.

Step 5 - add back in the £75,000 donation to MTS. This gives a figure of £438,830 - the ‘baseline amount’.

10 per cent of £438,830 is £43,883. The general component of Elizabeth's estate therefore qualifies for the reduced rate because she donated £75,000.

The reduced rate of Inheritance Tax means that the estate will only pay £130,978.80 compared to £145,532 if it had to pay at the full rate.

Survivorship component

The joint account passes by survivorship to Andrew, so this component cannot qualify for the reduced rate.

Where the amount qualifying for charity exemption in one component passes the 10 per cent test, the beneficiaries of the estate may choose to elect to merge with other estate components to gain the maximum benefit from the reduced rate. The following calculation shows how this can work based on the previous example.

10 per cent of the baseline amount for the general component of Elizabeth's estate was £43,883. So the £75,000 actually being given to charity was more than was needed to qualify for the reduced rate of tax. It may be possible to elect to merge the survivorship component with the general component of Elizabeth's estate so that the reduced rate of tax applies to both components. The following calculations show whether the merged components would qualify for the reduced rate of tax.

Step 1 - add the amount of the survivorship component (£30,000) to the value of the general component at Step 1 above (£675,000). This gives a figure of £705,000

Step 2 - deduct the nil rate band (£325,000) from the figure at Step 1 (£705,000). This gives a figure of £380,000.

Step 3 - add back the £75,000 donation to MTS. This gives a figure of £455,000 - the 'baseline amount'.

10 per cent of £455,000 is £45,500. The merged components of Elizabeth's estate therefore qualify for the reduced rate as the donated amount of £75,000 is more than 10 per cent of the baseline amount.

Back to Reducing IHT page