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24 Jun 2016

Author: adam-owens-att

Clients may sometimes want to give away assets to reduce their estate for Inheritance Tax (IHT) purposes. However, to be effective, the donor must not benefit from any asset gifted. This is not always possible – for example, where the donor relies on the income to fund their lifestyle. However, there is a way to get the best of both worlds by using a Discounted Gift Trust (DGT).

A DGT is a type of trust arrangement that enables a settlor to gift a lump sum into a trust whilst retaining the right to a regular payment.

The lump sum is typically invested, perhaps into an investment bond, and the trustees of the trust will make regular income payments to the settlor during their lifetime. It gives an opportunity at the outset to choose the payment level and its frequency. The underlying capital is then held on trust for the nominated beneficiaries.

The IHT implications of using a discretionary trust are discussed below. From an IHT perspective, the lump sum gift is separated into two parts:

The discount – an actuarial calculation is carried out to place a current day value on
the annual payments that the settlor can expect to receive. As this entitlement will cease on death, this element of the gift immediately falls outside of the settlor’s death estate.
The discount will depend on the level of payments that the settlor expects to receive. It will also depend on factors such as the settlor’s age and state of health. The longer the life expectancy, the more payments an individual is likely to receive, so the discount is likely to be larger.
The remainder – the lump sum less the amount of the discount is treated as a gift by the settlor. As this is a gift by the settlor to the trust, it is a chargeable lifetime transfer if a discretionary trust is used. However, providing this element falls within the available nil rate band (£325,000 less any chargeable transfers in the seven years before the DGT is set up) there is no immediate IHT consequences.
If the remainder value is in excess of the available nil rate band, there will be an immediate IHT charge at a rate of 20% of the amount above the nil rate band.
The value of the trust fund is not included within the estate of the beneficiaries.

IHT – on death

If the settlor dies within seven years of setting up the trust, the immediate tax charge will be recalculated using the full IHT tax rate of 40%.

IHT – exit charges

When money is paid out of the trust to the beneficiaries, either while the settlor is alive or after their death, there may be an exit charge. Where there is an exit charge, the maximum rate that will apply is currently 6%.

The regular payments made to the settlor are not subject to any exit charge.

Income Tax

Any income tax liability will depend on the investment product chosen.

Anyone thinking of using the DGT, must seek and rely on the advice of a suitable investment adviser and a suitable trust and tax practitioner.

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