If the settlor is considered to be in reasonable health, a calculation is made about the likely total amount of income that will be paid back to him by the trustees.
This is known as the discount and it’s deemed to be retained by the settlor.
The remainder will be treated like any other gift into a trust – such as a chargeable lifetime transfer (CLT) in the case of a discretionary trust, or a potentially exempt transfer (PET) in the case of a bare trust, falling outside the scope of IHT after seven years.
If the settlor dies within seven years, one might think that his retained discount should go to his personal representatives to form part of his estate. However, the HMRC tested and accepted IHT treatment is that this right to an income for life has no value once the settlor has died, and so no money has to be returned. The effect is that the discount is deemed to leave the settlor’s estate on day one of settlement of monies into the trust.
The rest of the money will be treated like any other gift into trust, and brought back into IHT calculations if death occurs within 7 years.
As a result of this, there is an immediate IHT reduction upon creation of a discounted gift trust, making it a powerful IHT planning tool for anyone in later life whose intentions are to draw income from their investments throughout their lifetime, then to pass on the remainder to their beneficiaries.
