Inheritance Tax Planning – Discounted Gift Trusts

Inheritance Tax Planning – Discounted Gift Trusts

Inheritance Tax Planning – Discounted Gift Trusts

Inheritance tax planning is an area that historically only affected the wealthy.  Sadly, as the nil rate band has been frozen since 2009, this is no longer the case and more and more families are being affected.

In some circles, inheritance tax is seen as an ‘optional tax’ but that is only the case in certain circumstances and if it is thought about far enough in advance and the correct planning is undertaken.

There are many tools that can be used to mitigate an IHT liability and one of these is a discounted gift trust and this works broadly as follows:

A lump sum is invested in a life assurance bond (through a trust) and this pays back an ‘income’ of say 5% per annum.  If the investor (settlor of the trust) survives for 7 years the amount invested is outside of their estate for inheritance tax purposes.  Additionally, depending on the age, health and gender of the settlor at the outset a discount is applied which is outside of the inheritance tax net from day one!

As an example, if £250,000 were invested with say a discount of £100,000 this would mean an immediate inheritance tax saving of £40,000 (£100,000 x 40%).  If the settlor were to survive the full 7 years then this would equate to an inheritance tax saving of £100,000.

As mentioned above, the investment would pay an ‘income’ to the settlor, equal to 5% per annum (lower rates can be specified) of the initial investment.  In our example, this would equate to a regular payment totalling £12,500 which would not be treated as income for income tax purposes.

What are the Pro’s and Con’s?

Pro’s

  • For those with spare cash, this is a valuable IHT saving tool.
  • Can generate tax free income
  • Immediate IHT saving on the discount amount which may be valuable in the event of an unexpected death within the 7 year period.
  • Any increase in value in the investment will be outside of the estate for inheritance tax purposes
  • If the settlor lives for 7 years the value of the investment is excluded from their estate

Con’s

  • For those making use of the gifts out of surplus income exemption the 5% per annum is deemed a return on capital not income
  • If the settlor does not need the 5% income and this is accumulating this will bring a further inheritance tax liability in its own right.
  • Loss of access to the capital

If based on the above, you have still decided that this is the right (or one of the right) planning tool(s) for you then there is a further consideration.  The life assurance bond above can be set up under either a discretionary or a bare trust.

Bare Trust or Discretionary Trust

If the bond is set up under a bare trust then this means that on the death of the settlor, the value of the investment will vest absolutely in the beneficiaries.  Whilst this is tax efficient from an IHT view point, this lack of control may not suit every settlor.

If the bond is set up under a discretionary trust then it falls to the trustees as to who gets what money when.  This may be more attractive to a settlor who still wishes to control the distributions to the beneficiaries.  However, this comes at a price.

If the original amount invested (after discount) exceeds £325,000 this will give rise to an immediate IHT charge of 20% of the excess.  Additionally, if the trust is still in existence at the 10 year anniversary of the investment then there will be a further 6% charge on the value of the investment in excess of £325,000 at that date.

If, after reading the above, you feel a Discounted Gift Trust (DGT) may be for you, or if you know that your assets are above or approaching the inheritance tax threshold and therefore that an inheritance tax review maybe beneficial then please contact us.

This is intended as an overview of how discounted gift type trusts may support IHT planning and therefore none of the content of this article is intended as investment advice  – specific professional advice is recommended before taking any action.

Gina Mills

Tax Manager

Peter Warren

Tax Director
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