When it comes to thinking about what happens to your wealth after you’re gone, you want to ensure your loved ones can make the most of your estate without large chunks being swallowed up by HMRC. A discounted gift trust (DGT) is a powerful inheritance tax planning tool that gives you a regular, tax-efficient income whilst potentially reducing your estate’s inheritance tax liability.
In this article, I’ll explain how a discounted gift loan works, the benefits of creating a DGT and its suitability for managing wealth and inheritance tax planning.
Inheritance tax planning
A common way to mitigate inheritance tax is to gift the money to a family member (other than your spouse or civil partner who would be exempt). The maximum tax-exempt amount you can gift each year is £3,000, but you might want to give away more than this. Any amount gifted to other family members over the maximum allowance could be a PET (potentially exempt transfer) and the value of that amount may only be free from IHT if you survive for 7 years after making the gift.
Realistically, most people don’t have the means to simply part with large chunks of capital during their lifetime. That’s why a discounted gift trust arrangement can be an attractive option because it allows you to invest money into the trust as a gift for your beneficiaries and retain access to some of the capital by way of regular fixed payments.
How does a discounted gift trust work?
Before creating a DGT, you have to consider your state of health and your age. You, as the settlor, will have to complete a statement of health form and based on this an actuarial calculation will be made to determine the likely amount of ‘income’ (technically capital repayments) you’ll receive for the rest of your life. Typically, these are annual withdrawals of up to the 5% tax-deferred allowance of the total amount invested.
The trust will usually be invested in either an onshore or offshore investment bond. You have a wide choice of investments and it’s worth taking time to talk with a professional financial adviser about what your options are.
Once the trust is created, the only access to your capital will be the preset, regular payments that you receive. This inflexibility may be off-putting for some, but the advantage comes from the fact that the total value of these fixed payments leaves your estate for IHT purposes immediately. Therefore, the ‘discount’ in discounted gift trust refers to this pre-set, inheritance-tax free amount.
Another big advantage is that the total amount invested into the bond at the outset is greater than the gift into the trust. This means the trust beneficiary gets even more from your money too as any growth in the investment stays outside the settlor’s estate.
However, it should be noted that the income payable will reduce the capital you hold and will not be payable once it has been exhausted. Furthermore, the exact amount of discount payable can only be confirmed as at the date of the death of the plan holder.
How can the trust be structured?
The two most common underlying structures for trusts are an absolute/bare trust and a discretionary trust.
Absolute/bare trusts are where the settlor names a specific beneficiary (or beneficiaries) from the outset. This cannot be changed at a later date, making it a less flexible option. The upside is that the gift is considered a PET (potentially exempt transfer) and will fall outside the settlor’s estate after 7 years.
For a discretionary trust, the settlor can nominate different classes of beneficiaries (e.g. grandchildren) and it’s up to the trustees to appoint who benefits when the time comes. This allows for more flexibility, for example, if subsequent grandchildren are born. If the trust is structured this way, the gift into the trust will be considered a CLT (chargeable lifetime transfer) and may be subject to an inheritance tax of 20% if the amount is above the nil rate band for inheritance tax.
Why are discounted gift trusts so attractive in inheritance tax planning?
If you want to make your inheritance tax planning as efficient as possible a discounted gift trust can give you big savings on inheritance tax right away and maximise the amount you leave behind for the ones you love.
In summary, the main advantages are:
- Instant savings in inheritance tax by removing the discount from your estate
- The remaining value of the gift potentially leaving your estate for inheritance tax after 7 years
- Receiving regular capital payments for a healthy cash flow
- All future growth on the trust stays outside your estate
One disadvantage is that unlike other trusts (such as the loan trust) which are more flexible, the DGT is not flexible at all once the trust has been created. Still, the immediate inheritance tax benefits can be considerable and depending on your age, the DGT might be an effective vehicle for your inheritance tax planning.
Is a discounted gift trust right for me?
If you have capital to invest and would like to make big inheritance tax savings on your estate whilst enjoying a steady stream of cash, a discounted gift trust may be for you. On the other hand, if you think you’ll need access to a lump sum of capital in the future, a more flexible arrangement, like a loan trust might be more appropriate.
The value of an investment with St. James’s Place may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation and reliefs from taxation can change at any time and are dependent on individual circumstances.
At Cooper Associates, we are experts in inheritance tax planning and can help you understand whether a discounted gift trust would be beneficial so that you can make an informed decision on your future finances. Get in touch today to see how we can make your money go further to help give the ones you love a head start in life.
