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Charitable giving and Gift Aid to optimise your tax strategy

By Daniel Barratt

  • Financial Planning

In the spirit of giving, contributing to charitable causes not only makes a positive impact on society but can also be a strategic way to manage your tax liability. The Gift Aid scheme is a powerful tool that allows taxpayers to boost the value of their charitable donations.

As the festive season approaches, Christmas becomes a pivotal time for charities in their fundraising efforts. The holiday spirit prompts individuals to engage in acts of generosity, and many charities launch special campaigns to harness this goodwill. This makes it an opportune time for individuals to consider how their charitable giving can not only spread joy but also optimise their tax position.

Gift Aid operates by allowing charities to reclaim 25p every time a taxpayer donates £1, at no extra cost to the donor. This additional contribution significantly enhances the value of the original donation, ensuring that charities receive more funding to support their missions. For the taxpayer, the benefits extend beyond the satisfaction of supporting a good cause – they can also leverage these donations to optimise their tax position.

When individuals contribute to a UK (and EU/EEA until April 2024) registered charity through Gift Aid, the donation becomes eligible for tax relief. This means that the taxpayer can claim back their marginal rate of income tax over basic rate relief. For those whose income surpasses the £100,000 threshold, engaging in charitable giving becomes an effective strategy to reclaim their Personal Allowance.

The Personal Allowance represents the amount of income an individual can earn before being subject to income tax. For every £2 of income above the £100,000 threshold, the Personal Allowance decreases by £1. By making charitable donations and utilising Gift Aid, individuals can effectively reduce their income, potentially bringing them below the £100,000 threshold and consequently reclaiming their full Personal Allowance.

This can work well when combined with pension contributions to reduce their own personal liability to tax and donate to causes they feel passionately about.

In essence, the combination of charitable giving and Gift Aid not only supports worthy causes but also presents an opportunity for individuals to optimise their tax position. By strategically planning donations, taxpayers can maximise the impact of their contributions while simultaneously benefiting from valuable tax relief, including the potential recovery of their full Personal Allowance for those earning over £100,000. It’s a scenario that aligns financial planning with philanthropic goals, making a positive difference in both individual lives and the broader community.

Charitable gifts also qualify for immediate Inheritance Tax (IHT) relief. In addition, gifting 10% of your net estate on death to a charity reduces the IHT tax rate from 40% to 36%.

Here is an example:

Mr Smith dies with a net estate of £100,000 and gifts £10,000 as part of his Will. The remaining £90,000 is taxed at 36% instead of 40%. The tax due is now £32,400, a reduction of £7,600 on the £40,000 tax due on the £100,000. The net payable to his beneficiaries is £57,600. 

Therefore, the £10,000 gift to charity only cost the beneficiaries £2,400. So whilst the inheritance is reduced, optimising the gift in a will to 10% reduces the cost of the gift through tax relief. 

Whilst gifting to charity does not give a net benefit to the individual, optimising the gifting strategy to take advantage of tax relief incentives can boost the value of a gift and reduce the overall tax burden.