If you have available cash and realisable investments, making a lifetime gift that is effective for inheritance tax (IHT) while retaining access to a regular flow of capital payments will usually be possible through a Discounted Gift Trust (DGT).
A Discounted Gift Trust may be appropriate where your two main objectives are:
- to make an immediately effective lifetime gift, and
- to secure the right to a fixed stream of payments, and
where you accept that, other than the regular payments, no access to the funds used in planning can be retained.
Types of Discretionary Gift Trust
Two types of Discretionary Gift Trust exist – one founded on a flexible power of appointment (POA) or discretionary trust and one founded on a bare trust.
Discretionary Trust – A Discounted Gift Trust can be based on a flexible power of appointment (POA) or discretionary trust which gives the investor/trustees flexibility over the choice of future beneficiaries. In general, such trusts will only be acceptable where the total of gifts made by the individual concerned (including the discounted value of the gift to the Discounted Gift Trust) in the seven years preceding the establishment of the Discounted Gift Trust, is well below the nil rate band for Inheritance Tax when the gift is made. Ten-year periodic charges and exit charges could apply.
Bare Trust – A Discounted Gift Trust based on a bare trust will offer no flexibility to change beneficiaries. Gifts to this type of trust will continue to be taxed as potentially exempt transfers (PETs) and the discretionary trust tax rules will not apply, with a proportionate part of the trust fund being treated as forming part of the beneficiary’s taxable estate. In particular, with a bare trust Discounted Gift Trust, no immediate Inheritance Tax charge will arise on gifts to the trust irrespective of size. Such gifts will, to the extent that they are not exempt, be potentially exempt transfers.
How it works
Regardless of the type of trust used, a Discounted Gift Trust is usually effected with a single premium life insurance investment bond subject to a special trust. It is, however, possible for a Discounted Gift Trust to be founded on non-insurance investments too.
The benefits of the trust fund (i.e. the bond) are (typically) held for beneficiaries under a flexible or discretionary trust or bare trust, but subject to the settlor being entitled to a specified cash sum if he or she is alive on specified dates.
On the settlor’s death, the entitlement to the cash payments ceases and so all the trust benefits are then held exclusively for the benefit of the beneficiaries under the trust.
There is no value in the settlor’s estate. The Inheritance Tax treatment of the Discounted Gift Trust will depend substantially on whether the trust on which the Discounted Gift Trust is based is a bare trust or a flexible or discretionary trust.
As the settlor retains the right to a stream of cash payments under the trust if he or she is alive on future dates, these rights have a value that stays in their taxable estate whilst they are alive. This means that the actual transfer of value to the trust for Inheritance Tax purposes will be an amount less than the investment made, giving rise to the concept of a discounted gift.
Who is a Discounted Gift Trust Suitable For?
In general, a Discounted Gift Trust could be a suitable choice for you if you:
- have cash to invest;
- wish to make a lifetime gift to reduce the value of their your estate for Inheritance Tax purposes immediately;
- need a regular flow of payments from the cash committed to the Discounted Gift Trust;
- are happy to only receive fixed payments from the Discounted Gift Trust with no access to capital;
- are in reasonably good health; and
- in the case of a flexible/discretionary trust Discounted Gift Trust, have not recently made and are not planning to make gifts in excess of the available nil rate band for Inheritance Tax;
- are comfortable with how the discretionary trust regime may operate in connection with the Discounted Gift Trust; or
- in the case of a bare trust Discounted Gift Trust, are happy that beneficiaries cannot be changed.
The advantages of a Discounted Gift Trust
A Discounted Gift Trust can provide you with:
- a fixed (or increasing) level of tax-efficient ‘income’;
- a reduction in the value being included in your taxable estate (even if you were to die within seven years of making the gift) if you are in reasonably good health and not very old;
- a further potential Inheritance Tax saving if you survive the gift by seven years;
- if the Discounted Gift Trust is established as a flexible/discretionary trust, control, normally (as trustee), over which beneficiary will benefit, when and by how much on the eventual distribution of the trust fund.
The disadvantages of a Discounted Gift Trust
The following are the disadvantages of a Discounted Gift Trust – even if set up on a flexible/discretionary basis:
- You have has no access to capital (other than the right to regular cash payments on the appropriate anniversary dates);
- You will need to undergo underwriting at outset;
- The settlor cannot enjoy ‘income’ in excess of the cash payment levels set out in the trust;
- There are potential Inheritance Tax charges if your nil rate band is exceeded, as well as reporting requirements;
- There is the potential for continuing (ten-yearly) charges and exit charges under the Inheritance Tax regime on flexible/discretionary trust Discounted Gift Trusts.
Some frequently asked questions
Can you vary your income level?
You cannot increase the ‘income’ level above those set out in the trust as otherwise this would be a gift with reservation. You can, however, give up your right to ‘income’. This will result in a gift of the ‘income’ given up to the trust.
Can a Discounted Gift Trust be set up on a joint basis?
You can set up a Discounted Gift Trust jointly with your spouse or civil partner provided that you both contribute to the trust. In this case, there will be two discounted gifts – one from each. If full ‘income’ continues to the surviving spouse/civil partner after the first death, then a part of each of those initial discounted gifts would be covered by the spouse/civil partner exemption.
Is it essential to undergo underwriting at the outset?
No but it is advisable. By undergoing underwriting it will be possible to determine the discounted gift at the time of establishing the arrangement. This will:
- help you decide whether or not to proceed with the arrangement; and
- help in establishing the discounted gift with HMRC if you were to die within seven years and HMRC were to contest the value of the discounted gift
Does the investment bond need to be surrendered on your death?
Assuming a life assured is alive there is no need to surrender the investment bond. It can remain as a tax efficient investment of the trust and be used in future tax planning. In the case of the flexible/discretionary trust, if surrender is contemplated so that a payment can be made to an adult beneficiary, it can be worth considering assigning the bond to that beneficiary pre-surrender if that beneficiary is a non, starting rate or basic rate taxpayer.
Can the investment bond be applied for on your spouse/civil partner’s life as well as your own?
Your spouse/civil partner can be a life assured under the bond, but this is not recommended.
Do the pre-owned asset tax rules apply?
HMRC has confirmed that, in general, the pre-owned asset tax (POAT) rules do not apply to Discounted Gift Trusts.
Links to more information
- Inheritance Tax
- Money Advice Service notes on Setting up a Trust
- If you need personal financial advice on a Discounted Gift Trust then I am happy to introduce you to Flying Colours Life who have access to independent financial advisers throughout the UK
This information does not constitute personal advice and should not be treated as a substitute for specific advice based on your circumstances.
Information given relating to tax legislation is based on my understanding of legislation and practice currently in force. Whilst I believe my interpretation of current law and practice to be correct in these areas, I cannot be responsible for the effects of any future legislation or any change in interpretation or treatment. In particular you are warned that levels of tax and tax reliefs are subject to alteration and, in any case, the value of such reliefs and benefits may depend on an individual’s circumstances.
If you are in any doubt as to whether any course of action is suitable for you, then you should discuss the matter with a suitably qualified independent financial adviser or other specialist.