Inheritance tax receipts to HM Revenue & Customs are increasing and are likely to continue do so. This is despite the IHT nil rate band being frozen at £325,000 until 2025-26 and the introduction of the £175,000 residence nil rate band.
A discounted gift trust is an IHT planning tool that you can use to reduce the potential IHT liability for clients who need income and have some investible assets available.
Quite simply, a DGT is an arrangement that allows you to make a gift for IHT purposes while providing you with an income to meet your ongoing living requirements.
Due to the nature of the trust, it can provide an immediate reduction in your client’s potential IHT liability.
DGTs may be suitable for clients who:
- Have a potential IHT liability as well as cash to invest.
- Need an ongoing income that they are likely to spend.
- Would like to make a lifetime gift to immediately reduce the value of their estate for IHT purposes.
- Are happy to only accept fixed payments of income with no further access to capital.
- Are under 90 years of age and in reasonably good health.
- Want to invest on a joint basis.
How a DGT works
A DGT is usually set up alongside an investment in a single premium investment bond (onshore or offshore) or capital redemption bond. Depending on how the trust is set up, the settlor (person setting up the trust) has a right or entitlement to receive:
- An income for life; or
- Specified cash sums if they are alive on dates specified in the trust.
Once set up, the level of income cannot be altered. The trust can either be a discretionary or an absolute (bare) trust.
To determine the value of the gift for IHT purposes, the settlor’s entitlement is valued actuarially at the outset. This is based on the client’s age, health and lifestyle, and can include underwriting.
The transfer of value for IHT purposes will be the sum going into the trust (the amount invested in the bond) reduced by the value of the settlor’s entitlement – hence the concept of a discounted gift.
The younger and healthier you are, the larger the discount and the greater the potential saving.
On the settlor’s death, the entitlement to the income payments ceases. The investment is then held exclusively for the benefit of the beneficiaries under the trust.
Calculating the level of the discount
When initially setting up the DGT, the settlor sets the level of regular capital payments or ‘income’ – to be paid for the duration of their lifetime or until the fund is exhausted – from the associated investment bond.
For IHT purposes, the total value of these payments is carved out from the original gift.
However, it is assumed that this value remains in the estate because the settlor may receive this as income and it has not been given away. This is known as the discount.
The product provider medically underwrites the settlor to establish their life expectancy, based on their state of health and lifestyle.
Using their age, or rated age, the provider calculates the market value of the income stream – the amount that will be retained and not given away if the settlor lives up to the date when they are expected to die.
The younger and healthier the settlor, the higher the market value of the income stream because they may live for longer. For the same reasons, both the discount and potential saving to IHT at outset are also greater.