Many individuals want to reduce the potential inheritance tax payable by their estate on death. However, a good number of these are not in a position to just give capital away as they require a continuing income.
Naturally this poses a real problem for advising them. What they need is a Trust that can shelter the capital but also enable regular payments to the settlor. A Discounted 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.
When an individual invests a lump sum into a Discounted Gift Trust the money is invested in an investment bond, this can be either an Onshore or Offshore solution depending on their individual circumstances. 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 investing in a Discounted Gift Trust, because the settlor retains the right to the regular payments, these payments have a capital value which does not form part of the gift for inheritance tax purposes.
The gift to the trust is ‘discounted’ by the capital value of the regular payments. Any amount invested over the value of the discount is treated as a gift for inheritance tax purposes and will remain in the settlor’s estate for the next seven years. For example, if a client invested £100,000 and requested withdrawals of £5,000 each year, depending on underwriting the value of the regular payments could be deemed to be projected at £53,000. This is outside of their estate immediately and the remaining £47,000 would be a gift.
Income tax benefits
The use of an investment bond allows the settlor and trustees to utilise favourable tax treatment. An investment bond is a non-income producing asset and any growth or income achieved by the underlying assets remain in the bond, and do not give rise to any immediate tax liability.
It is possible to take regular withdrawals from the bond without any immediate liability to UK income tax. Withdrawals of up to 5% of the amount invested can be taken each year and for tax purposes are deemed to be a return of capital – hence the withdrawals are termed as regular payments rather than income.
Many clients will want, or need, regular payments to supplement their income, a Discounted Gift Trust may provide the ideal solution. With the arrangement allowing the client to receive tax efficient income and ultimately removing the capital from their estate after 7 years, it ticks a lot of boxes. As independent financial advisers we can carry out the research to find the right provider to suit the client’s needs. You being able to highlight options available for inheritance tax planning once you have dealt with their Will can only help to enhance how a client thinks of you and your service.
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