My wife and I are 69 and 72 respectively, in excellent health and have an adequate income plus considerable savings. After making use in our wills of Nil Rate Band Discretionary Trusts, we find that we still have a considerable IHT liability. On my death, my wife’s income will drop considerably as her right to my inflation proofed company pension will be reduced by nearly a half and she might need some additional investment income. On the other hand, if my wife were to die first, I will have more income than I really need and could let my children have a substantial part of my spare capital.

I am considering setting up a Discounted Gift Trust from my own funds with my children as main beneficiaries and my wife as a potential beneficiary. I would take the absolute minimum capital repayment allowed by the Trust, hopefully allowing the fund to grow! I would also ensure the money was available for any potential IHT liability, were I to die before 7 years were up.

After I die, could my wife receive a regular taxable payment from the Trustees of the fund until she dies, the Trust then being wound up in favour of the main beneficiaries?

Mark McLaughlin CTA (Fellow) ATT TEP, General Editor of TaxationWeb, selects a 'question of the month' from TaxationWeb's Tax Tips Forum.

Introduction

There was a time when inheritance tax (IHT) was only a major concern for individuals with significant wealth. Alas, times have changed, and with property prices having increased much faster than the annual increases in the IHT nil rate band, probably a larger proportion of the population than ever are left to ponder how much of their hard-earned wealth will eventually be claimed by the Government in the form of an IHT bill. It is perhaps unsurprising that IHT planning is therefore becoming an ever more popular topic.

‘Discounted Gifts Trusts’ (DGTs) (or ‘Estate Planning Bonds’, as they are sometimes called) can be used in IHT planning. An introduction to DGTs was provided in an article by Bob Fraser in February 2006. As mentioned in that article, a DGT arrangement typically involves an investment in a life insurance investment bond, which is placed into trust so that it falls outside the investor’s estate. The arrangement is intended to provide an immediate discount on the value of the investment. The balance is a gift for IHT purposes. However, since Bob’s article, Finance Act 2006 changed the IHT treatment for certain trusts (the original announcement of the changes in Budget 2006 actually resulted in some providers withdrawing DGTs for a time, but in most cases they have since reappeared).

Following FA 2006, the gift element of the arrangement is a chargeable lifetime transfer for IHT purposes. This means that if the value of the gift, plus any other chargeable transfers in the previous seven years, amounts to more than the nil rate band (£285,000 for 2006-07), IHT will be chargeable at 20% on the excess. Some care will therefore be required when determining the value of the chargeable gift. Of course, whether DGTs are suitable at all will depend on individual circumstances, as the following query illustrates. Specific professional advice is therefore essential.

Query from TaxationWeb visitor ('kestrel1'):

My wife and I are 69 and 72 respectively, in excellent health and have an adequate income plus considerable savings. After making use in our wills of Nil Rate Band Discretionary Trusts, we find that we still have a considerable IHT liability. On my death, my wife’s income will drop considerably as her right to my inflation proofed company pension will be reduced by nearly a half and she might need some additional investment income. On the other hand, if my wife were to die first, I will have more income than I really need and could let my children have a substantial part of my spare capital.

I am considering setting up a Discounted Gift Trust from my own funds with my children as main beneficiaries and my wife as a potential beneficiary. I would take the absolute minimum capital repayment allowed by the Trust, hopefully allowing the fund to grow! I would also ensure the money was available for any potential IHT liability, were I to die before 7 years were up.

After I die, could my wife receive a regular taxable payment from the Trustees of the fund until she dies, the Trust then being wound up in favour of the main beneficiaries?

Editor’s Comments

The ‘holy grail’ of IHT planning (apart from paying no IHT!) is probably to make full use of the ‘nil rate bands’ of both spouses when they die. It would appear that ‘Kestrell’ and his spouse have already achieved this objective. ‘Kestrell’ is therefore considering some lifetime IHT planning. Of course, there is more than one way for individuals to reduce the value of their estate, other that a DGT. For example, one option (as mentioned by Bob Fraser below) is a lifetime discretionary trust. Such as trust could make use of the individual’s available nil rate band every seven years, for example by making cash gifts to the discretionary trust for family members (although the trust settlor must be exclude from any benefit).

There are other lifetime planning possibilities, such as IHT-efficient investments (e.g. shares in unquoted or AIM listed trading companies) or taking advantage of available reliefs and exemptions (e.g. the exemption for normal expenditure out of income, or gifts for the maintenance of family members in certain circumstances). The most suitable planning option will depend upon individual personal circumstances, which vary. This is why specific, expert professional advice is always recommended.

Responses from contributors included:

Arnold Aaron said:

I would not put your wife as a beneficiary, as this could trigger other taxable consequences, such as a gift with reservation of benefit.

Why not set it up with both of you as joint settlors/donors, so that the income would continue after first death for the surviving spouse.

Bob Fraser commented:

Based on the information that you have stated, I do not agree that the Discounted Gift Trust is necessarily the optimal solution for you. This view may change if the amount you are considering settling into trust exceeds £285,000 or if you have already settled up to £285,000 into a discretionary trust in the past 7 years.

From what you say, the situation is that you do not need the additional income, but your wife would. You state that you would draw the minimum amount during your life, but then presumably your wife would need to draw much more if she survives you. Unfortunately a DGT requires the level of income to be (largely) decided at the outset, since this "carves out" the retained amount, and then allows the amount of the gifted sum to be recorded. A DGT is consequently not as flexible in varying the income as you appear to need.

My view is that the first brick in your financial planning could be a discretionary trust, settled by you, and with your wife and children as potential beneficiaries. You and your wife could be 2 of the trustees. This would then allow you to postpone any benefit from the trust until it is needed whilst starting the 7 year "clock". If you predecease your wife, she could then start to take withdrawals from the trust. If she predeceases you, you could then wind up the trust in favour of the children at a time when it may be more advantageous to them, rather than having to wait to your death.

Please note that this opinion is in the absence of a fuller understanding of your circumstances. If you need a more detailed discussion, please call/contact me.

Arnold Aaron added:

On reflection of the information you have provided, why not gift the capital to your wife and then she set up the Discounted Gift Trust.

This would mean the income would continue for her for life, and if you pre-decease her there is no IHT to pay on what you have gifted to her under the inter spouse exemption.

If she predeceased you the DGT funds simply pass on to the beneficiaries, which you have said would probably do anyway.

Bob's suggestion is viable, however getting involved in discretionary trusts can be daunting as far as tax forms are concerned - the IHT 100 would need to be completed, and any previous gifts made to a discretionary trust will come into the picture.

Bear in mind Discounted Gift Trusts are available under Bare versions which avoid all these issues with discretionary trusts, though you cannot change the beneficiaries.

Bob Fraser said:

As the initial planning tool in an IHT mitigation exercise, I am not sure that the sale of a DGT and taking income where none is initially required is appropriate, since the surplus income then accumulates inside the estate. Whilst surplus income can of course be gifted, assuming that the annual exemption is not already used, this is merely an attempt to overcome an inefficient approach.

I am not sure that I would reject a discretionary trust in favour of setting up a DGT simply to avoid completing forms.

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