A Discounted Gift Trust (DGT) can be an effective estate planning tool for individuals looking to reduce their Inheritance Tax (IHT) liability while retaining a fixed income stream for life. By gifting capital into a trust, a portion of the amount transferred—known as "the Discount"—is immediately exempt from IHT, while the remaining amount is treated as a gift subject to the standard seven-year rule. If the settlor survives for seven years after making the gift, the full amount will be exempt from IHT. Additionally, all investment growth is immediately outside of the settlor’s estate for IHT purposes.
Key features of a Discounted Gift Trust
- Immediate IHT Benefit: A portion of the gifted capital receives an immediate IHT exemption, reducing the taxable estate.
- Fixed Lifetime Income: The settlor retains a regular fixed payment for life.
- Seven-Year Rule: The portion of the gift not covered by the discount is usually subject to the standard seven-year IHT rule.
- Investment Growth Outside the Estate: Any investment growth achieved within the trust is immediately outside the estate for IHT purposes.
- Control Over the Trust: The settlor can act as a trustee, maintaining oversight of the trust’s assets.
- Potential for Multi-Generational Planning: The trust structure can allow assets to pass efficiently through generations while maintaining an element of control.
- Asset Protection Benefits: Trust assets are protected from direct access by beneficiaries, ensuring strategic wealth preservation.
How a Discounted Gift trust works
The fixed payment from the trust is determined at the outset based on several key factors. These include the settlor’s age, health status, and life expectancy, which are assessed through medical underwriting. The actuarial team then calculates the appropriate level of Discount by estimating the expected duration over which payments will be made. This Discount represents the present value of the retained right to payments, reducing the portion of the gift that is immediately subject to IHT.
Example scenario:
A couple transfers £500,000 of surplus capital into a DGT, selecting an annual income of 3% (£15,000 per annum). Based on their age and health, the actuarial team applies a discount of 40%, meaning that £200,000 is immediately outside of their estate. The remaining £300,000 is subject to the seven-year rule.
If the couple survive for seven years, and assuming no other gifts impact the timeline, the entire amount becomes IHT-free.
IHT exposure before establishing a DGT
Without any estate planning, the full £500,000 would remain within the taxable estate, potentially subject to IHT at 40% upon death.
IHT exposure upon setting up a DGT
- £200,000 (Discounted Amount): Immediately exempt from IHT.
- £300,000 (Gifted Amount): Remains subject to the seven-year rule.
IHT liability after seven years
Provided the settlors survive for seven years, the full £500,000 is exempt from IHT, potentially saving £200,000 in tax (based on the 40% IHT rate).
Structuring the Trust
A DGT can be established on a single or joint-life basis, each with its own benefits and considerations. The most appropriate structure depends on individual circumstances and estate planning objectives.
A Discretionary Trust is commonly used for these arrangements, offering:
- Flexibility: Classes of beneficiaries can be included rather than named individuals, providing adaptability for future changes.
- Family asset protection: Ensures assets are managed and distributed according to the trustee’s wishes.
- Tax considerations: Periodic (10-year) and exit charges apply, and IHT at the lifetime rate of 20% may be due if the non-discounted portion exceeds the available Nil Rate Band (£325,000 per individual).
Investment Considerations
DGTs are often established using an Investment Bond (either onshore or offshore) as the underlying investment vehicle. This structure provides:
- Tax-efficient growth within the bond.
- Access to withdrawals of up to 5% per annum of the original investment, without an immediate tax liability.
- Investment management: Clients can appoint a Discretionary Investment Manager to oversee the trust funds, aligning with their broader investment strategy (including General Investment Portfolios, ISAs, and Self-Invested Pensions).
A Discounted Gift Trust can be a powerful estate planning solution for individuals seeking to mitigate IHT while retaining a stable income. However, these trusts are complex and require careful consideration of taxation, investment strategy, and estate planning objectives.
As with any financial planning, there is no “one-size-fits-all” approach. Professional advice is essential to determine the suitability of a DGT within an individual’s overall estate planning strategy.
For more information on estate planning and how a DGT might benefit your circumstances, please ask your Investment Manager to put you in touch with our team of Wealth Planners.
The information provided in this article is of a general nature and is not a substitute for specific advice with regard to your own circumstances. You are recommended to obtain specific advice from a qualified professional before you take any action or refrain from action.
