Discounted Gift Trust – Inheritance Tax planning

Inheritance Tax

Discounted Gift Trust – Inheritance Tax planning

Do you want to know more about saving Income Tax and Inheritance Tax through sophisticated (but simply explained) planning and the option of a Discounted Gift Trust and or other useful planning tools?

If so, then this article may be useful. It is the first of a number of blogs about the use of trust planning as a means to saving Inheritance Tax in the UK, and this blog focuses on the use of the discounted gift trust. This it is just one solution from a range of options, but none the less a useful one for some.

Trusts generically are as complicated as people want to make them, yet they really are not that difficult to understand at all.

How does Inheritance Tax work?

If you believe that simply by leaving the UK you can avoid tax on your worldwide assets, think again. For example, if you move to Spain but your beneficiaries are in the UK, then they will receive proceeds from your estate. The “executers” of your will, especially legally qualified or regulated, have a legal obligation to report any such transfers to HMRC. However, also, dissatisfied beneficiaries (those that do not receive what they think they should have) will often happily report tax matters to HMRC. Be aware that bank accounts receiving money in other countries come under new reporting requirements (see HMRC warns all UK residents with overseas assets   Are all UK IFAs aware of this?).

Unless you are 100% sure that your estate has no Inheritance Tax to pay in the future, then your estate will have to pay 40% tax on any qualifying inheritance in excess of the current nil rate band, prior to monies being released through probate.

So, what can be done to assist with this position?

Discounted Gift Trust

A Discounted gift trust is a popular Inheritance Tax planning tool for UK- domiciles (or UK non-domiciled residents) who have surplus capital that they wish to gift to future generations and who are relatively healthy (I will come back to this). For a definition of what domicile means click here.

If a UK domiciled individual (including sometimes a non-UK resident that has been an expat for some time) gifts something, but still gets benefit from the gift, then this is termed a “gift with reservation of benefit”. Therefore, it would be treated as if the gift had never been made and would be included in the individual’s estate for the calculation of UK Inheritance Tax.

HMRC state “A discounted gift trust or plan is where the settlor makes a gift into settlement with certain ‘rights’ being retained by them. The retained rights may, for example, be a series of single premium policies maturing (usually) on successive anniversaries of the initial investment, reverting to the settlor (the person that gifted the money), if alive on the maturity date; or the settlor carves out the right to receive future capital payments if still alive at each prospective payment date. The gift with reservation provisions do not apply.”

This confirms that if a “carved out” interest is properly constructed within the trust, there is no gift with reservation. This means that someone can gift monies into trust and retain a right to an income from the trust, while obtaining immediate and longer term Inheritance Tax savings. However, they can no longer access the capital.

How does the “carve out” work in practice?

There is a well-known phrase “You can’t have your cake and eat it”, so we can use the analogy of a cake to explain the carve out. In this case, a “slice” of the cake is reserved for the donor of the gift (settlor). As this “slice” is not given away, there is no reservation of benefit issue .This “slice” will provide the settlor with a regular income. However, the rest of the cake is given away without condition absolutely for the ultimate benefit of the selected beneficiaries and the donor can no longer eat it, although they can continue to monitor it and have input on the management.

How does the discount work?

The “slice” is not simply deemed to be valued as equivalent to that part of the cake, or put another way a 3/5th slice of the cake is not valued as 3/5th of the total value of the cake. Indeed, the cake might be deemed devalued and be worth a lot less than the 3/5ths, say only 2/5ths in monetary terms.

In the real world this means the “slice” needs to be valued by an actuary who calculates by reference to the health of the donor, the amount of regular payments to the donor and the age of the donor. The actuary calculates the “value” of the future payments.

If, for example, a £100,000 gift was valued at £50,000, then the settlor would have received an immediate discount on the gift for Inheritance Tax purposes; effectively saving £20,000 IHT during the first seven years of the trust. After seven years, the gift is now outside of the estate.

How is the discount on a discounted gift trust actually calculated?

To use another analogy, a theoretical buyer of the slice would want to pay a lower amount for the slice if there was a commitment to paying a regular income for a long time to a healthy person and so would ask for a discount. This values the slice significantly lower than the actual capital.

Would a hypothetical buyer of the income slice expect to get a large discount for the future lifetime regular income of someone who is terminally ill? The answer is no, this means the value of the discount would be low/zero.

This shows why the discount must be underwritten at outset to ensure tax efficacy.

For those that have a life expectancy of over 3 years, but possibly less than seven years, then greater Inheritance Tax savings are available after three years for the part of the gift that exceeds the nil-rate band (currently £325,000), due to Taper Relief. However, care must be taken to ensure that the correct trust is established to prevent a Chargeable Lifetime Transfer (Subject of a future blog).

Trust structure

As with all of these structures, it is important that the correct trust wordings are used and that appropriate tax advice is given at outset. Additionally, it is important that the correct investment structure is established to maintain tax efficacy.

The discounted gift trust is very Inheritance Tax efficient, if used correctly. This does allow people to ‘have their cake and eat it’. However, it is important to point out that the regular income to the donor must be paid for this to be effective as a tax planning tool. Also bear in mind not all countries recognise trusts and there are often very little double tax agreements in place when it comes to wealth tax or inheritance tax.

Take action without delay on mitigating Inheritance Tax

If you think that you could be affected by UK Inheritance Tax and you require assistance (not with just a discounted gift trust) why don’t you contact us for a no charge discussion on your situation?

We, as a company, have spent years specialised in this complex field and work with legal advisers to establish the most robust solutions. We have advisers who have won the prestigious Money Management Inheritance Tax Planner of the year award.

We even made local history by setting up the first Czech Trust Association and the first trusts in the Czech Republic!

Always check the experience of the advisers who have the required expertise, so we look forward to hearing from you.

The views expressed in this article are not to be construed as personal advice. You should contact a qualified and ideally regulated adviser in order to obtain up to date personal advice with regard to your own personal circumstances. If you do not then you are acting under your own authority and deemed “execution only”. The author does not except any liability for people acting without personalised advice, who base a decision on views expressed in this generic article. Where this article is dated then it is based on legislation as of the date. Legislation changes but articles are rarely updated, although sometimes a new article is written; so, please check for later articles or changes in legislation on official government websites, as this article should not be relied on in isolation.

This article was published on 23rd August 2017



Chris Lean

Chris is a Chartered Financial Planner who writes blogs and articles to simplify and explain some of the financial issues that affect UK expats. Subjects include; hot topics, regulation and the ever-changing world of finance.

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