Inheritance tax (IHT) is charged at a rate of 40% against the value of the assets of an individual on their death, subject to allowances and exemptions. The responsibility for paying the tax generally lies with that individual's executors. If the deceased individual has left at least 10% of their net estate to charity, the executors can report and pay the IHT at a reduced rate of 36%.
The components
In determining its eligibility to pay IHT at the reduced rate, the legislation splits the deceased's estate into the following three "components":
- The survivorship component: jointly owned assets held by the deceased which pass to the other joint owner(s) by survivorship, such as a share in a property subject to as special destination;
- The settled property component: assets subject to a qualifying interest in possession to which the deceased was beneficially entitled immediately before their death, such as a pre-March 2006 or immediate post-death liferent trust; and
- The general component: any other assets held by the deceased.
The reduced rate of 36% will apply to the tax due from an individual component if the charitable legacy payable from that component is at least 10% of the net value of the component. This can lead to a scenario where part of the estate is taxed at 36%, with the remainder being taxed at 40%. This is unless the option to merge the components is available.
It is important to note that failed potentially exempt transfers or chargeable lifetime transfers cannot benefit from the reduced rate. However, gifts with reservation of benefit may be included as a separate component.
The deceased's available IHT nil rate band will be apportioned pro rata among the three components.
Merging the components
If the charitable legacy is large enough, in that it exceeds 10% of the net value of more than one of the components combined, the executors (and other interested parties) can elect to merge those components. If such an election is made, the reduced rate of 36% will apply across the merged components.
An election to merge the components must be made within two years of the deceased's date of death by all parties responsible for paying the IHT. So, in addition to the executors of the estate, the election must also be made by, for example, the trustees of the settled property component and/or the surviving owner of the survivorship component.
Often, the executors of an estate and the trustees of a pre- March 2006 or immediate post-death liferent trust will be the same people. However, it is not uncommon for these parties to be partially or entirely separate. The need for the election to be signed by all those responsible for paying the IHT therefore means that an element of cooperation and coordination may be required among separate parties. In a case involving different executors and trustees, it is possible that each party will have instructed their own solicitor, meaning good communication between those solicitors is very important.
How the calculation is carried out: a worked example
Jack died in May 2025. His wife, Diane, predeceased him in November 2023 and left everything to Jack under her will. Jack's will leaves one half of the residue of his estate to his nieces and nephews (his brother Nicky's children) and the other half to various charities.
When Jack's mother died, she left an investment portfolio to him in liferent, with the portfolio passing to Nicky's children following the termination of the liferent. The portfolio is worth £250,000 on the date of Jack's death.
Jack and Nicky (who survived Jack) owned two properties which they rented out. The title deeds to both properties state that they are held equally between Jack and Nicky and the survivor of them. The properties are worth £250,000 each on the date of Jack's death.
The net value of all of Jack's remaining assets is £1m. The IHT due on his death will therefore be calculated as follows:
Survivorship (£) | Settled (£) | General (£) | Total (£) | |
Assets | 250,000 | 250,000 | 1,010,000 | 1,510,000 |
Less: Debts | ______________ | ____________ | (10,000) | (10,000) |
250,000 | 250,000 | 1,000,000 | 1,500,000 | |
Less: Charitable legacy | ______________ | _____________ | (500,000) | (500,000) |
250,000 | 250,000 | 500,000 | 500,000 | |
Less: Nil rate band | (162,500) | (162,500) | (325,000) | (650,000) |
Potentially taxable estate | 87,500 | 87,500 | 175,000 | 350,000 |
Add: Charitable legacy | ______________ | _____________ | 500,000 | 500,000 |
Baseline amount | 87,500 | 87,500 | 675,000 | 850,000 |
10% of the general fund | 67,500 | |||
As the charitable legacy of £500,000 is greater than 10% of the general fund (the baseline amount), the reduced IHT rate of 36% is available to that component.
Rate | 40% | 40% | 36% | |
Taxable estate | 87,500 | 87,500 | 87,500 | 350,000 |
IHT | 35,000 | 35,000 | 63,000 | 133,000 |
However, the charitable legacy is also greater than 10% of the total baseline amount (£85,000), meaning the executors, trustees and surviving joint owner may elect to merge the components. The result of this election would be as follows:
Rate | 36% | 36% | 36% | |
Taxable estate | 87,500.00 | 87,500.00 | 87,500.00 | 350,000.00 |
IHT | 31,500.00 | 31,500.00 | 63,000.00 | 126,000.00 |
As shown above, merging the components would mean Nicky and the trustees of the liferent trust owing £31,500 each in IHT and Jack's executors owing £63,000. This represents tax savings of £3,500 each for Nicky and the trustees.
Taking advantage of the reduced rate of inheritance tax is something that many people set out to achieve through careful estate planning, often through specific clauses in their wills. However, if a deceased person also happened to benefit from a qualifying interest in possession trust or held joint assets passing by survivorship, it may not always be apparent to the trustees or surviving joint owner that the reduced rate may also extend to them.
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