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Discounted Gift Trusts

Introduction

This briefing provides a generic overview of discounted gift trusts (DGT), how the discount is determined and what happens after the settlor has died. The specifics of individual product provider DGTs may vary, and these should be checked separately.

Core considerations  

  • Discounted gift trusts are used for effective IHT planning.
  • The settlor is absolutely entitled to a regular payment stream until death, from the investment bond.
  • The capital is held in trust for their chosen beneficiaries.
  • The settlor may receive a discount on the value of the transfer into trust for IHT purposes.

Contents


What is a discounted gift trust?

Discounted Gift Trusts (DGT) are used by individuals who are looking to carry out inheritance tax (IHT) planning whilst retaining a right to regular ‘income’ payments during their lifetime and intend spending those regular payments.

A DGT is usually established with an investment into a single premium investment bond (life assurance or capital redemption contract). The trust fund (i.e. the bond) carves out the right for the settlor to receive ‘income’ during their lifetime. After the death of the settlor, the trust fund is held for the beneficiaries.

There are different types of DGT’s available, these include discretionary, absolute or interest in possession trusts.

Generally, the regular ‘income’ payments amount and frequency are chosen at outset and cannot be changed.

Where a DGT is a discretionary or interest in possession trust, the trustees have flexibility over the choice of future beneficiaries and control over when they become entitled. A gift into these trusts is a chargeable lifetime transfer (CLT) and if the settlor exceeds £325,000 in a 7-year rolling period the excess will be subject to an IHT entry charge.

An absolute trust offers no flexibility to change beneficiaries or to control the point at which the beneficiaries become entitled to the trust fund. Gifts to this type of trust are potentially exempt transfers (PETs).

Under both types of trust the value of the transfer is based on the premium paid (or the value of the policy if an existing bond is assigned into it) by the settlor, less any discount granted.
 

The Discount

Individuals who are reasonably healthy and under age 90 may be entitled to a discount on the value of the transfer. The age limit of 90 is industry wide arising from HMRC valuation rules. For settlors older than that, the discount will be nominal.

The reason that a discount may be granted is due to the regular payment stream that is paid back to the settlor throughout their lifetime. The younger and healthier the client the longer the payment stream is likely to continue and therefore more is taken back – and the bigger the discount. 

Generally, product providers will underwrite the DGT based on a report from the settlor’s doctor, however they reserve the right to ask for a medical to be carried out. This allows the insurer to assess the settlor’s mortality and how long the regular payments will be paid. Discounts can range for 0% to 100%, depending on the health of the settlor up to and including the time the gift is made into the DGT.

The illustrative discounts issued by product providers are not guaranteed. HMRC reserve the right to examine each case, which may include requesting sight of the medical information for the settlor. 


What access do the settlors have to the trust fund?

The settlor only has a right to regular income payments for their lifetime. Their entitlement is fixed and generally can’t be changed. There is an absolute indefeasible right to receive these payments and the trustees must ensure that the value of the trust fund can support the settlor’s right to receive them.

Where there are joint settlors, the payments continue until both have died.


What happens to the DGT when the settlor dies?

Most providers’ DGTs will not allow payments to the beneficiaries whilst the settlor is alive. Beneficiaries can usually only benefit after the settlor(s) have died.

The trustees can choose to encash the bond and distribute the trust fund to the beneficiaries, or they could choose to keep the bond invested.

Under an absolute trust, the beneficiaries are absolutely entitled. If they are 18 in England and Wales or 16 in Scotland, they can demand payment of their entitlement.  

Under a discretionary or interest in possession DGT, the trustees can decide who will benefit and when they will benefit from the trust fund. As long as the beneficiary is in the class of beneficiaries the trustees can distribute the trust fund to them. 

For example

After her husband passed away Yvonne’s income has reduced but having inheriting all of his assets she now also has an IHT issue. Her adviser recommends that she invests £350,000 into a discounted gift trust. This will top up her income and give her regular payments until she dies, leaving the remaining capital to her beneficiaries at that time. 

Setting up the DGT she will create a transfer of value on her estate for IHT purposes. She elects to use a discretionary trust which means she is also able to do intergenerational planning thus leaving a legacy for future generations. As she is fit and healthy for her age, she is entitled to an immediate discount of £130,000 which falls outside her estate - discounting the value of the transfer from £350,000 to £220,000.

The figures provided in this example are for illustrative purposes only.


 

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