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REVIEW SUMMARY

Discounted Gift Trust

A discounted gift trust (DGT) is usually set up in connection with an investment in either an onshore or an offshore investment bond or insurance bond.

A DGT allows for the gifting of a lump sum into a trust, while retaining a lifelong income from that money, which is technically one or more withdrawals of capital.

The main aim of the trust is to reduce the eventual IHT liability for the settlor on death.

Overview
FAQ
Customer Reviews
Expert Verdict

A discounted gift trust allows the settlor (or settlors) to make an inheritance tax effective gift whilst retaining a right to fixed regular payments for the remainder of their lifetime. The value of the settlor's gift for IHT will be discounted by the estimated value of these future retained payments.

The trust establishes two rights:

  • The settlor's right which is to pre-agreed regular payments for life
  • The beneficiaries' right to the trust fund in the case of settlor's death

As it is separately identifiable as to what has been given away and what is retained for the settlor, there's no gift with reservation for IHT.

Discounted gift trusts may be set up on a single or joint settlor basis (for spouses and civil partners only). When spouses or civil partners consider creating a discounted gift trust (DGT) they will need to decide whether one joint settlor or two single settlor DGTs is most appropriate.

Facts about the Discounted Gift Trust:

  • On the first settlor's death, the right to retained payments on a joint settlor Discounted Gift Trust will typically continue at the full amount.
  • Right to the retained payments will cease upon the first death if the two settlor Discounted Gift Trusts are selected. 
  • If the settlor that survived is also a beneficiary of the one that passed, they can then benefit from the trust and get a larger lump sum payment of regular amounts.
  • Joint discounts are calculated based upon combined life expectancy (if both settlors die).
  • Based on the settlor's life expectancy, the discount will be split and is not equal.
  • This would result in a slightly different overall discount compared with two single settlor DGTs (depending on individual circumstances and conditions prevalent).

A discounted gift trust will typically offer three trust options. These are:

  • Discretionary trust
  • Flexible (interest in possession) trust
  • Absolute trust.

Under the discretionary trust, no beneficiary has a right to either income or capital. The trustees are able to appoint income or capital at their discretion to any beneficiary within the class of potential beneficiaries named in the trust deed.

The flexible trust names the beneficiaries who are entitled to any trust income. However, if the trust is invested in an investment bond, no income is produced. The trust includes an overriding power of appointment which allows the trustees, which will usually include the settlor, to alter the beneficiaries or their respective shares in the trust. This is especially useful where the settlor may want to alter the beneficiaries in the future. For example, where there are new beneficiaries born after the trust is created, such as grandchildren, or perhaps where the named beneficiary falls out of favour.

Under the absolute trust, the beneficiaries are fixed at outset and cannot be amended by the trustees at a later date. The beneficiary of the absolute trust only becomes entitled to the capital and income from the trust after the retained payments cease upon the death of the settlor. When selecting the absolute trust, the settlor should be certain of who they ultimately want to benefit from the trust.

Key features of a discounted gift trust (DGT):

  • A discounted gift trust allows a settlor to give away assets and still enjoy regular payments for life
  • The amount treated as given away for IHT may be discounted by the future value of the regular payments which have been retained
  • To be effective for IHT, payments should be spent by the settlor and not retained in the estate
  • The right to the regular payments ceases on the settlor's death and has no value
  • Beneficiaries are unable to benefit from the trust until after the settlor has died

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, so no money has to be returned. 

The rest of the money will be treated like any other gift into the trust and brought back into IHT calculations if death occurs within seven 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 their later life, whose intentions are to draw income from their investments throughout their lifetime and then pass on the remainder to their beneficiaries.

We would highly recommend reading the 'expert verdict' section of this review to make an informed decision.

 

 

The Pros

> Allows settlor to make an IHT effective gift whilst retaining a right to future capital payments during their lifetime
> The value of the settlor's gift for IHT may often be discounted by the estimated value of the future capital payments
> Can be written as a bare or discretionary trust

The Cons

> Settlor must be in reasonable health to obtain significant discount
> Relatively inflexible, as the income stream cannot be altered
> Gifts into the trust will be PETs or CLTs
What will the discount rate be?

The discount rate is calculated based on both mortality rates for your age, as well as an in-depth medical testing to determine a fair discount factor for the gift, based on the value of the retained revenue stream.

What if I need to recall the capital?

By using a discounted gift trust, you give up the right to the capital and can only access the income stream which is set at a pre-agreed amount (and is inflexible).

Who is the DGT appropriate for?

A discounted gift trust is an estate planning vehicle designed for individuals, or married couples/civil partners, who have excess capital they are prepared to give away but still need payments from their capital to supplement their income.

The gift into trust will provide an immediate IHT saving if a discount is agreed*. The whole value of the gift will be free from IHT if the settlor survives it by 7 years.

The settlor receives pre-agreed regular payments that are fixed for their lifetime. The payments cannot be amended once the policy has commenced. This will suit those that are looking for the certainty of receiving known amounts for the rest of their days. If the regular payments are not being spent and are being accumulated within the estate, it may undo the effectiveness of the estate planning.

* Any discount is subject to satisfactory underwriting

How is the trust created?

The trust is typically established by the settlor making a cash gift to the trustees. It isn't normally possible to use an existing bond or other investment to create the trust - these will generally need to be encashed and the proceeds used to establish the discounted gift trust.

The trustees then invest the trust funds by taking out an investment bond (onshore or offshore) although some schemes use a series of endowments. Regular withdrawals are set up to provide the settlor's capital payments.

The use of non-income producing assets, such as bonds or endowments, means there's no trust tax reporting needed unless there's a chargeable gain. 

Is it possible to change the trust assets?

The trust provisions will determine whether it's possible to change the underlying investments. If they do, there are some important considerations for the trustees.

  • The surrender of the original bond could give rise to a chargeable gain, which could result in income tax upon the settlor.
  • The trustees must be able to replicate the settlor’s right to capital payments under any new investment. The trust assets may have fallen in value if the withdrawals taken exceed the investment growth. Investing the proceeds into a new bond will mean the available 5% tax deferred allowance may be lower than the amount needed to pay the settlor’s retained payments. As a result, there may be chargeable gains each year.
  • There may be no support from the original provider and no access to the original underwriting to agree discounts with HMRC should the settlor die within the first seven years.
What are the exit charges?

The regular withdrawals made to the settlor as part of the settlor's retained payments are not treated as exits. This is because the settlor's retained payments are held upon a bare trust for the settlor and are not relevant property.

Where capital is paid to a trust beneficiary - for example, after the death of the settlor or where the trust provisions permit, advanced to the beneficiary during the settlor's lifetime - there will potentially be an exit charge.

The IHT on the exit is charged at a proportion of the effective rate applying at the last 10 yearly charge or 30% of the effective rate on creation. This means that where the effective rate was 0% at the last review date - for example, where the original transfer was below the available nil rate band - there will be no charge applied when capital leaves the trust.

Have you used a discounted gift trust?

Have you got experience of establishing a discounted gift trust (DGT)?

Would you like to share your experience and opinion to help other people make an informed decision?

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Expert assessment of a discounted gift trust (DGT)

A discounted gift trust (DGT) can be a useful solution, but whether it is applicable has to be determined on a case-by-case basis, as does the case for using trusts in general.

If you already have a trust structure in place and would like a Second Opinion - or, if you are wondering whether the utilisation of a trust could be of benefit to you, contact us.

 

NOTE: Because trusts are so unique to each individual, it’s impossible to give them a rating for their overall performance and suitability. Therefore these reviews do not come with a star rating.

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