Estate Planning Guide

DISCOUNTED GIFT ARRANGEMENTS The major difference between a discounted gift trust (DGT) and a gift and loan trust is that with the DGT the settlor does make a gift for IHT purposes and therefore relinquishes control of capital. The investment bond within the trust is set up in such a way to ensure that regular withdrawals are paid to the settlor at pre-agreed dates and in pre-agreed amounts, normally for the settlor’s lifetime. The payment interval and the amount of each payment is pre-determined and once set, the amount of each payment cannot, for the most part, be varied. For tax purposes, these regular payments are actually deemed to be a return of a portion of the capital that was used by the settlor to make the gift (the Settlor’s Fund). This is generally true of all bond withdrawals. The proportion of the capital gift that will be required to maintain these regular payments throughout the settlor’s life is calculated when the bond is established, based upon the settlor’s health and expected lifespan. As with the gift and loan trust, the 5% per annum tax deferred withdrawal rules apply if an insurance bond structure is used. Again, the growth in the value of the underlying investments is outside the settlor’s estate from day one (the Residual Fund). It is held upon trust for the beneficiaries and, because the underlying insurance bond cannot be surrendered, this fund cannot be accessed during the settlor’s lifetime. These arrangements generally involve the settlor transferring an insurance or capital redemption bond to a DGT. The proportion of the value of the gift that is expected to eventually be returned to the settlor as regular payments during their lifespan is called the ‘discount’. This calculated value immediately falls out of the settlor’s estate for IHT purposes. This is because HMRC have agreed that this capital sum (the ‘discount’) will not be deemed to have a value at the date of death, as the regular payments will cease at that time. The remaining value of the investment is a gift for IHT purposes and will fall out of the settlor’s estate after a seven year period. This structure allows individuals to get more money outside of their estate, but they will receive regular payments, which if unspent, will accumulate in their estate. There are three critical points to consider: • The potential advantage of an immediate discount may be attractive to some clients in poor health, but poor health could lead to HMRC challenge – reducing or removing the discount; no discount is available to clients aged 90 or over. But proper underwriting and use of HMRC guidance greatly reduce the possibility of HMRC challenge. • If settlors live for longer than seven years the whole of the initial PET or CLT will become exempt from IHT and the discount becomes irrelevant. But the settlor is now “locked in” to receiving a level of regular payments which cannot be varied at any time during the rest of their life. • If the regular payments become surplus to requirements, it can’t be turned off. The end result could be that the initial gift is simply re-accumulated back into the settlor’s estate thereby completely defeating the object of the exercise. If the repayments are gifted onwards they will, for tax purposes, be treated as gifts of capital and will not qualify as gifts of surplus income. If no evidence of health has been obtained at the outset, HMRC take the view that a discount is not justified unless medical evidence sufficient to underwrite the settlor’s life to the standards required for whole of life assurance was already in existence and can be produced, should it be necessary to quantify the gift at a later date. For this reason, all providers now generally insist on full full medical underwriting at outset. In terms of the regular amounts received by the settlor, if the underlying investment is structured as an insurance or capital redemption bond, withdrawals will typically be treated for tax purposes as capital rather than as income receipts. The generally accepted view is that the amounts received may be gifted onwards, using annual IHT exemptions, but will not be regarded as available income for the purposes of the exemption for normal expenditure out of income. HMRC prefers that full medical underwriting should be carried out before the DGT is effected, including sufficient medical evidence to underwrite the settlor’s life to the standards required for whole-of-life assurance. The intention is that the evidence can be produced should it be necessary to quantify the gift at a future date. In addition, although significant IHT savings may be achieved, an insurance or capital redemption bond based arrangement will at best defer a potential IT liability, the level of which will be determined by how the fund is distributed by the trustees. Most major insurance companies offer this type of arrangement and a choice of onshore or offshore bond structures is generally available. The key factors to consider are the provider’s financial strength, the choice of investment funds available, the charges involved, the provider’s administrative efficiency and the availability of an appropriate form of trust. Litigation has resulted in HMRC’s position, that the discount in cases where the settlor is aged 90 or over (actual or deemed) at outset, has only a nominal value (probably £250). £100,000 DGT investment bond £57,350 RESIDUAL FUND £42,650 SETTLOR’S FUND Out of estate in 7 years Out of estate inmediately Income of £5,000 pa SOURCE: BOND DICKINSON WEALTH Each client scenario is unique, so an IHT calculator, such as www. IHTcalculator.com, can prove useful for financial planners, allowing them to input assumed growth rates for the value of different assets and calculate potential future IHT liabilities on the rising value of the estate. HENNY DOVLAND, SENIOR BUSINESS DEVELOPMENT MANAGER, TIME INVESTMENTS 41 40 ESTATE PLANNING OPTIONS ESTATE PLANNING OPTIONS