Discounted
Gift Trusts
The number of people in the UK subject to Inheritance Tax (IHT) has
dramatically increased. IHT is levied at a rate of 40% over and above
the IHT nil rate band that applies at the date of death. For those
people whose estates may be liable to IHT on death, a Discounted
Gift Trust (DGT) may provide an effective means of mitigating some
or all of the potential IHT liability on their estate.
What is a Discounted Gift
Trust?
In order to establish a DGT, the
individual (the settlor)makes a gift
to a trust. The value of the gift is
invested within the trust into a
single premium investment bond.
The arrangement will stay in place
throughout the settlor’s lifetime.
The settlor can decide who they
then wish to benefit from the
capital within the DGT upon their
death (the beneficiaries).
The investment bond within the
trust is set up in such a way to
ensure that a regular ‘income’ is
paid to the settlor at pre-agreed
dates and in pre-agreed
amounts. For tax purposes, this
‘income’ is actually deemed to be
a return of a portion of the capital
that was used by the settlor to
make the gift. The proportion of
the capital gift that will be required
to maintain these ‘income’
payments throughout the settlor’s
life is calculated when the bond is
established, based upon the
settlor’s health and expected
lifespan.
Calculating the ‘Discount’
The proportion of the value of the
gift that is expected to eventually
be returned to the settlor as an
‘income’ during their lifespan is
called the ‘discount’. The value of
the ‘discount’ is calculated at the
outset and immediately falls out
of the settlor’s estate for IHT
purposes. An immediate IHT
saving is therefore made, of 40%
of the value of the discounted
sum.
The remaining value of the gift will
fall out of the settlor’s estate
gradually over the next few years,
with the gift falling out of the
estate entirely if the settlor
survives for seven years after
making a gift.
Why Do Discounted Gift
Trusts Work?
Under the present IHT rules, if a
person (the donor) makes an
outright gift of funds out of their
estate, they cannot receive an
income from the funds that they
have gifted away. The donor
would be seen as deriving a
benefit from the assets and this
would fall under the Gift With
Reservation rules. HMRC would
calculate any IHT due on death
as though the gift had never been
made.
When a DGT is used, the
‘income’ that is taken from the
investment and the capital value
required to sustain these
payments is calculated. HMRC
have agreed that this capital sum
(the ‘discount’) will not be
deemed to have a value at the
date of death. The value of the
‘discount’ does not therefore
form part of the estate for the IHT
calculation and, as such, this fund
has fallen immediately out of the
estate.
It is very important that the
‘discount’ is calculated
accurately, to ensure that the
value of the fund is not
challenged by HMRC.
Example
Ted Johnson is a 60 year old
non-smoker in good health. He
invests £100,000 into a DGT,
taking an ‘income’ of £5,000 per
annum. The actuary calculates
that the amount of capital
required to provide this ‘income’
throughout Ted’s life is £42,650.
This sum therefore falls out of
Ted’s estate immediately. This
creates an immediate tax saving
of £17,060 (40% of £42,650).
The remainder of the gift,
£57,350, will fall out of Ted’s
estate fully if he survives for seven
years after making the gift. After
seven years, the tax saving will
therefore increase to £40,000
(40% of £100,000).
Advantages of a
Discounted Gift Trust
• Investing in a DGT can be an
effective way to reduce an
individual’s estate immediately,
with the possibility of further
reducing the value of the estate
over the following seven years.
• Utilising a DGT allows the
settlor to take an ‘income’ from
the investment, whilst still
reducing the estate for IHT
DGT Investment Bond
£100,000
‘Income’
of £5,000
per annum
The Gift Portion
£57,350
Out of
Estate in
7 years
The ‘Income’
Portion
£42,650
Out of
Estate
Immediately
purposes. This method of
planning may therefore be
suitable for someone who
wishes to minimise their IHT
liability, but who relies upon their
capital to provide them with an
income and does not therefore
wish to make outright gifts.
• Any growth in the value of the
investment belongs to the DGT,
and therefore will not form part
of the estate for IHT purposes.
What to Look Out For
• The ‘income’ payments may fall
back into the settlor’s estate for
IHT purposes. The settlor
should aim to spend the
‘income’ when they receive it,
or gift it away.
• Whilst HMRC have confirmed
that DGTs will not fall under the
Gift With Reservation rules at
present, legislation may change.
Regulatory changes may
challenge the tax advantaged
status of such schemes in
future.
• The settlor must undergo
underwriting, and medical
problems may be discovered at
this stage. Not only will this
reduce the immediate IHT
saving, but the discovery of
medical problems can be
unwelcome and worrying.
• ‘Income’ payments may erode
the capital value of the
underlying investment bond if
they are set at too high a level.
This would reduce the value of
the fund eventually available to
pass to the chosen
beneficiaries.
• The investment bond itself will
contain one or more underlying
funds. These funds may be
subject to stockmarket
movements and may fall in
value as well as rise.
• Once the level of withdrawals
have been established, these
cannot subsequently be
changed.
Jane Wilson
Manager
www.bonddickinson.com
T: +44 (0)191 279 9899
E: jane.wilson
@bonddickinsonwealth.com
Bond Dickinson Wealth Limited is a limited company registered in England and Wales under no: 8375875
Bond Dickinson Wealth Limited is a wholly owned subsidiary of Bond Dickinson LLP.
Bond Dickinson Wealth Limited is authorised and regulated by the Financial Conduct Authority and their firm reference number is 596652.
BD.1248
Last updated May 2014