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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.
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 distinct rights:
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.
The retained payments
The right to the retained payments on a joint settlor DGT will typically continue at the full amount after the first settlor's death.
However, if two single settlor DGTs are selected, the right to the retained payments on one trust will cease upon the first death. This could be an issue where the surviving settlor relies on the retained payments.
Where the surviving settlor is also a beneficiary of the first settlor's trust then they can of course still benefit from that trust, either in the form of regular payments or larger lump sum payments.
Joint discounts are calculated based upon combined life expectancy, that is, on the probability of both settlors dying. The discount is not appointed equally but split based upon each settlor’s own life expectancy. This may give a slightly different overall discount compared with two single settlor DGTs, but it will depend upon individual circumstances.
A discounted gift trust will typically offer three trust options. These are:
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):
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.
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.
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
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.
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 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.
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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.
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.