A STUDY OF GIFTING: DISCOUNTED GIFT TRUSTS
Last month we looked at how a loan trust can be an option for those starting out on a gifting journey – no actual gift is made while growth is immediately outside of the estate and the donor can access the loan at any time. So, it satisfies the need for access but does not involve any reduction in the value of the donor’s estate until such time as some or all of the loan is no longer required with a gift being made at that time.
How it works
For those wanting to transfer a significant amount out of their estate while still having access, the Discounted Gift Trust (DGT) could be an ideal solution. The donor will receive regular payments from the trust fund as stipulated in the deed – these payments must be made and cannot be stopped or reduced as the discount is predicated on the payments being received by the settlor during their estimated life expectancy.
Estimating the donor’s life expectancy is part of determining the discount that will apply to the gifted amount. It is therefore important to underwrite the donor to see if their age needs to be “increased” for medical underwriting purposes, and thus whether the standard life expectancy should be reduced.
For donors who passed away soon after making the gift and had an underlying medical condition that could have impacted their life expectancy, HMRC may disallow or reduce the discount. This could mean an IHT charge if the gift was made on a discretionary basis and the donor’s nil rate band (NRB) is now exceeded. The following example shows how the discount is arrived at.
Discretionary DGT
| Donar's Age | Donar's underwritten age | Amount of gift | Regular Payments | Estimated discount | Estimated gift |
|---|---|---|---|---|---|
| 68 | 71 | £500,000 | 4% pa | 37.6% | £312,000 |
So, although the donor’s estate has been reduced by £500,000, this only represents a chargeable lifetime transfer of £312,000 as the donor will be receiving £20,000 a year back into their estate for the remainder of their life expectancy. There is therefore no initial IHT charge as the discounted gift is within the donor’s NRB (assuming no other chargeable lifetime transfers have been made by the donor in the previous seven years).
It may be that the donor’s health or age is such that no discount can be given so that the full value of the gift will be a transfer for IHT purposes. However, the donor will still receive the regular payments as a key part of their income provision and the gift value will be outside the estate after seven years.
Trustee investment
Investment bonds could be ideal as the investment vehicle for a DGT. The regular withdrawal facility can be used to provide the regular payments to the donor, while the ability to assign individual policies to beneficiaries when trust funds are distributed means the responsibility for accounting for any tax arising on surrender of the policies will be that of the beneficiaries, who can use income tax allowances and reliefs where relevant which are not available to trustees.
If the DGT is a bare trust, the beneficiary will be responsible for paying tax on any chargeable gain (unless the donor is a parent of a minor child beneficiary, and the gain, combined with income from other trusts of the donor for the same beneficiary, exceeds £100 in a tax year, in which case the donor will be liable for the tax). The beneficiary can use their income tax allowances to offset the gain.
For discretionary trusts, the donor is responsible for paying any tax on chargeable gains arising during their lifetime or in the tax year of their death, with the trustees responsible thereafter. Assigning individual policies to the beneficiaries means subsequent gains arising will be liable to tax at their rate of income tax rather than the trustees’ rate, which is 45% on anything above £500 in a tax year, and reliefs and allowances are available to the beneficiaries but are not available to trustees.
How rigid is the DGT structure?
A DGT provides a pre-determined level of regular payments for the life of the settlor as well as discounting the value of the gift for IHT purposes. The discount applies to the extent that the regular payments continue to be made, so what happens if the payments are no longer needed once the trust has been in existence for at least seven years?
By foregoing the regular payments, the donor would be making a gift of the outstanding amount and thus be making either a potentially exempt transfer or a chargeable lifetime transfer depending on whether the trust is written on a bare or discretionary basis. The amount being gifted would have to be calculated by appropriate specialists which would incur a not insignificant cost. Alternatively, payments could continue to be made to the settlor who could then spend or gift them as required.
All information is based on our understanding and interpretation of applicable law and regulation.