Gift & Loan Trusts, Discounted Gift Trusts (DGTs) and Flexible Reversionary Trusts (FRTs) are commonly used IHT planning structures that let a settlor retain some form of access. They're often considered alongside each other as each can make payments back to the settlor, but the mechanics and the outcomes for a client's estate are quite different. We’ve been having lots of conversations with advisers all across the UK about these three structures and how they compare, here is a summary below based on our understanding . This comparison is based on the specimen wordings that Transact offer, the features available from other providers or the terms of other trusts may vary.
How each trust works:
Gift & Loan Trust
The settlor creates a trust with a small gift (often covered by an available inheritance exemption such as the annual exemption) and then a much larger loan to the trustees. The gift and the loan are then invested.
The loan can be repaid to the settlor in instalments (e.g. 5% p.a. over 20 years) or can be recalled on demand. Any outstanding balance is repayable on death of the settlor. The loan can be waived by the settlor at any point, including in their will. During the life of the settlor, waiving the loan will be a transfer of value. Where the loan is released under the terms of the settlor's will, the outstanding loan balance will still form part of the settlor's estate for IHT purposes.
Any growth on the trust fund attributable to the loaned capital will generally accrue outside the settlor's estate from the date of settlement.
In effect, this type of arrangement is a gift of the future income and capital growth on the loan and the longer the loan remains in the trust the more beneficial this type of trust will be.
We have specimen wording for bare and discretionary trusts.
Discounted Gift Trust (DGT)
The settlor gifts a capital sum into trust in return for a fixed series of payments for life. These amounts can be paid in annual, quarterly or monthly instalments and are fixed for life.
Broadly speaking, the capital cost of those payments is calculated at the outset and this reduces the settlement value for IHT purposes (the “discount” element of the DGT).
As the capital cost of the income will vary based on the age/life expectancy of the settlor, it is recommended that the settlor undergoes medical underwriting. This should limit the possibility of any challenge to the discount if the settlor dies shortly after making the gift.
From an IHT perspective, the amount of the discount is outside the estate immediately; the balance of the gift is a Potentially Exempt Transfer or Chargeable Lifetime Transfer (depending on trust type).
As the trust provides payments that are fixed for life from the outset, a DGT can help support a client’s need for income.
The trustees usually invest in a bond and make use of the 5% tax deferred withdrawal allowance to make payments to the settlor.
We have specimen wording for both a bare and a discretionary trust.
Flexible Reversionary Trust (FRT)
The settlor pays a premium to establish a bond which is written into trust. Both our onshore and offshore bond are available for use with our FRT but it is only available as a discretionary trust. This means that the settlement should be a chargeable lifetime transfer.
The bond consists of 1,000 policies by default, although a smaller number can be selected.
At the outset, the settlor specifies how many policies they would like returned to them at each “vesting date” (vesting dates coincide with policy anniversary dates)
If the settlor is alive at the vesting date, they become entitled to the policies specified in the schedule.
However, the trustees have the power to defer the vesting dates or override the settlor’s entitlement. So, before each vesting date, the trustees can decide whether the payments should be deferred until some future point, or distributed to beneficiaries.
If no action is taken, policies vest automatically on the vesting date specified in the schedule of the trust deed.
By having the power to defer the settlor’s entitlement, the trustees have the flexibility to only make the policies available to the settlor if they are required.
On death of the settlor any policies that have not reverted to the settlor are held on trust for the beneficiaries.
The settlor’s entitlement is to policies of the bond, the value of which will change over time.
Good record keeping of the trustees’ decisions is essential and we recommend considering the use of professional trustees to assist with the administration and maintenance of the trust.
Trust comparison summary
| Gift & Loan Trust | Discounted Gift Trust | FRT |
|---|---|---|---|
Gift for IHT | Nominal – loan stays in the settlor's estate | The gift for IHT is reduced by the capital cost of the future payments | Full value of settlement – no discount |
Settlor access | The amount of the outstanding loan | Fixed payments for life, set at outset | Scheduled bond policies subject to trustee discretion to defer. |
Flexibility of settlor access | Loan can be recalled at any time or waived | Payment amount fixed at outset | Trustees may defer or allow vesting in accordance with the trust deed. |
Underwriting | Not required | Medical underwriting is normally undertaken to support the discount calculation | Not required |
Impact on estate | All growth and income, outside of the estate – the loan itself remains in the estate until repaid or waived | Discount immediately outside of the estate; balance on survival of 7 years | Value remaining in trust may fall outside the estate after seven years |
Important: The information above is intended as a general guide only. The tax treatment of a trust will depend on the trust deed, the settlor’s circumstances and prevailing legislation and HMRC practice, which may change in the future.
In summary
Gift & Loan Trusts, Discounted Gift Trusts and Flexible Reversionary Trusts all seek to reduce the value exposed to inheritance tax whilst allowing the settlor to retain some level of benefit. The mechanisms used to achieve this are fundamentally different: a Gift & Loan Trust retains a repayable loan, a Discounted Gift Trust retains a fixed right to future payments, and a Flexible Reversionary Trust provides conditional rights to future bond segments. Understanding the nature of the retained benefit is key to determining the IHT treatment, the level of flexibility available and whether the arrangement is suitable for a client's wider financial objectives.
If you have a question not covered above, or would like to discuss a specific client scenario, please contact Transact Technical Support: Technical_Direct@integrafin.co.uk or call 020 7608 5300.
All information is based on our understanding and interpretation of applicable law and regulation which is subject to change. Tax treatment depends on individual client circumstances and may change in the future.