In the UK, everyone can pass on £325,000 of their estate on death without paying any inheritance tax, and, as of last April, there is an additional amount of £100,000 available (subject to conditions).
For a UK domiciled or deemed domiciled individual, any assets over this wherever in the world they are located are generally subject to tax at 40 per cent.
This can be a significant amount and can leave Her Majesty’s Revenue and Customs as a major beneficiary to an estate.
Many people look at ways of mitigating inheritance tax and the correct use of a trust can offer a tried and tested method of getting money outside of an estate during someone’s lifetime. For this purpose gifts, using a discretionary trust, should not exceed the £325,000 nil rate band as tax charges could apply at outset.
A discounted discretionary gift trust is a popular solution and, whilst reducing the potential inheritance tax payable, also allows the investor to retain access to a series of regular payments that can be used to supplement income.
When an individual invests a lump sum into a discounted gift trust the money is invested in an investment bond. This can be an onshore solution through a provider based in the UK or an international provider based overseas, such as the Isle of Man or Ireland. As part of the application process regular payments from the bond are selected at the outset and once the bond has been established it is assigned to a specially designed trust: a discounted gift trust.
The trust uses a ‘carve-out’ so the individual who creates a trust, the settlor, retains the right to the regular withdrawals during their lifetime and, after their death, the value of the fund is then available to the trustees. At that time the trustees can then either distribute the trust assets to the beneficiaries or retain them until a later date if they choose.
Inheritance tax benefits
When making lifetime gifts, the inheritance tax position is based on the ‘loss to the estate’ principle – how much has the individual’s estate reduced by making a gift. For a cash gift the estate is normally reduced by the value of the cash gift, however, sometimes it is not that simple.
When investing in a discounted gift trust, the settlor retains the right to the regular payments and these payments have a capital value. As part of the application process the provider will need to calculate the actuarial value of these payments and this will depend on a number of factors, such as interest rates, the amount of the payments and the health and lifestyle of the settlor. This enables the provider to establish the life expectancy of the settlor and how long the payments are likely to be paid for.