A discounted gift trust (DGT) is an investment into trust, which can be highly efficient for inheritance tax (IHT) purposes.
At one time, DGTs formed part of the bedrock of deathbed planning; but no longer. HMRC insists that the individual be medically underwritten to establish what the discount is. Briefly, your investment is divided into two parts. One part is set aside as a discounted income stream (the ‘discounted portion’) which gives you an immediate reduction from IHT. The second portion is a potentially exempt transfer (PET) where you are gifting the investment to children or grandchildren, or others (see below). If you survive for seven years after making the gift, it will be out of your estate (plus the growth on it), for IHT purposes. If you die within seven years, the relief is tapered.
Criteria
- Age - The younger you are, the greater is normally the discounted portion, and hence the greater the immediate IHT saving.
- Health – Better discounts are generally available the healthier you are, and if a non-smoker. The discount is medically underwritten to avoid disputes with HMRC later.
- Gender – DGT’s are now gender neutral, so the advantage of the traditional female younger life is lost.
- Income – The greater the level of income stream taken the bigger the discount.
- Locked in – Once taken, the DGT investment cannot be unwound.
- HMRC tables – Gender non-specific rates are based on the female mortality table for both men and women.
- Taxation – You are taxed on excess income over an annual withdrawal amount of 5% of the investment (after deducting your personal allowance).
If the discounted portion is part of an absolute trust, it is not caught by the trust taxation rules; the balance is gifted as a PET (potentially exempt transfer) to beneficiaries and is out of your estate after you have survived for seven years (falling back into your estate on a tapered basis if you fail to survive seven years, where a proportion will be subject to IHT at 40%, if over the IHT nil rate band (£325,000 in 2014/15). Your beneficiaries receiving the value of the investment will have to pay the IHT, if any, unless you stipulate that your estate is liable for it.
The DGT gives a fixed income to the settlor for life; it can be for joint lives or joint incomes. The higher the level of income chosen, the greater the discounted portion for IHT purposes. Grandparents can pay for school fees using this income, for example.
Current position
HMRC guidance (published on 6 August 2013) states that from 1 December 2013 discounts calculated for new discounted gift schemes have to be gender neutral. At the same time, the interest rate used to take account of the effect of inflation on the settlor’s fund would be 4.5%. An example using the new neutral gender rate and comparing it to the previous position is as follows:
Example - Potential IHT saving
Mrs Smith is aged 71 and wishes to invest into a discounted gift trust bond to provide her with an income for life. She wishes her grandchildren to benefit from the investment after she has died. She is a non-smoker. She can invest £100,000. Her health is good. She requires 5% income from her investment, fixed at that level for life.
Pre 1.12.2013 Post 1.12.2013
Discounted portion for immediate IHT relief £50,280 £54,360
Balance as a PET – seven year survival £49,720 £45,650
Total Investment £100,000 £100,000
Immediate IHT savings at 40% £20,112 £21,744
Further savings after seven years at 40% £19,888 £18,260
Full IHT savings £40,000 £40,004
In the above example, whilst the calculations may be different because of the gender neutral rules (and change in inflation rate used), the end result is the same – an IHT saving of £40,000.
Practical Tip:
DGT’s remain popular to immediately reduce your estate for IHT purposes, with the full saving on your investment (and its growth) after seven years. Consider IHT sheltering your investments. As always, seek independent financial advice first, based on your personal circumstances.
