Discounted Gift Trusts (Part I): The Tax Savings and The Tax Costs
For well over a decade discounted gift trusts have enabled thousands of clients to make Potentially Exempt Transfers (and latterly Chargeable Lifetime Transfers (CLTs)) while retaining a regular capital withdrawal from the gift. All without falling foul of the FA 1986 gift with reservation of benefit provisions.
Devised under Counsels’ direction, these plans had most commonly been based on an investment bond established subject to a flexible power of appointment trust. The capital withdrawals were generally made possible via a “carve out” arrangement within the trust. Furthermore, these plans provided an immediate reduction from the chargeable estate: the “discount”.
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The planning works via either a discretionary or an absolute trust; and therefore with extra tax and flexibility considerations.
Female Client aged 60
Assuming a client’s health and a standard underwriting of life expectancy, our actuarial discount table shows that a discount of 70.8% is available for a 60 year old female. This is the initial discount if she were to choose a 5% per annum withdrawal back to herself. Therefore, from a £750,000 gift, £531,000 will be “carved out” immediately and only £219,000 will be a CLT.
On investment being made, a discounted gift trust provides an immediate reduction in the chargeable estate. This is the “discount”, the present value of the “carve out”.
The Benefits of a Discounted Gift into a Discretionary Trust
- Exactly as Pre FA 2006, the discount or “carve out” has the effect that if our client were to die immediately after effecting the transfer, an immediate saving of £212,400 (£531,000@40%) would have been made to the inheritance tax liability.
- If she were to live a further seven years, a further saving of £87,600 (£219,000@40%) would be made, in today’s money.
- She will also now receive £3,125 each month (£37,500/12) into her current account. A 5% per annum capital withdrawal for which there will be no income tax payable in her annual income tax return. An effectively 5% net income will be at much higher levels than can be generated from a standard portfolio. Furthermore, the amounts are fixed and are paid monthly, direct to the client’s bank account.
- An advising probate practitioner is not required to undertake such trust planning internally. They are able to take advantage of a tried and tested plan, packaged for use by their clients.
- The plan is packaged with a pro-forma discretionary (or bare) trust which can aid planning for later generations.
- The investment arrangement of this type of product, within a unit linked bond, enables the trustees to be in an ideal position from which to discharge their duties under the Trustee Act 2000.
- The plan includes the cost of medical underwriting. This is of considerable value to an estate plan. Not only will it help validate the discount/”carve out” at later death, it also corroborates the value of making any type of large gift of settlement (or other complex planning) at that client’s advanced age.
- The above adds up to very effective tax planning at an extremely low professional indemnity risk to the legal practitioner.
The next article will consider other issues surrounding the Discounted Gift Trusts.
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