Deconstructing the Discounted Gift Trust Q&A

You mention that one cannot usually assign an existing bond into a DGT - can you expand on this, why not? when is it possible?

It can be done but assigning an existing bond into a DGT is generally not allowed due to underwriting and commercial reasons.  We believe it’s generally better to start with a new bond to ensure a clean tax-deferred allowance and appropriate life-assured basis.

If settlor's circumstance change, can settlor access the Bond?

No, like any IHT effective trust, the settlor cannot access the bond once it is placed in the trust other than their own rights in the case of a DGT, their reversions in respect of a RIT or the loan in the case of a loan trust.

How do you unravel a DGT if need access to funds?

You cannot unravel a DGT to access funds. Like any IHT effective trust the settlor cannot get access.

A court could revoke the trust but the court must be satisfied that the trust was a result of fraud, undue influence or mistake which should not be applicable where professional advice is taken.

What is the position of the £60,000 gift Vs the £100,000 put into the trust for estate planning purposes?

The discounted amount (£60,000) is the value used for IHT calculations, not the full amount (£100,000) put into the trust.

I know the client's health impacts the discount element.  For example would a client having a stent fitted be a non starter?

Having a stent fitted does not automatically disqualify a client, but it suggests other health conditions that could affect underwriting.

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 in existence when the transfer into trust is made (not after).

Is it possible to withdraw regular payments from a DGT and use these to fund a whole of life policy?

Yes, but the payments are considered capital, not income.  So, assuming the WOL is under trust the premiums would be further gifts.  Normal expenditure exemption would not be available.  

What are the issues if the settlor decided not to take an income and the bond has now passed 20 years, can he now access the income he didn't take as a lump sum?

This is complex and would likely require legal advice. Not taking the income could be considered a gift, which has IHT implications. Alternatively leaving the income in the trust could give the settlor a benefit that could also have IHT implications. You should always take the income (and spend it).

What is the average age of a DGT client? Is it 74?

Close, for us the average age of a DGT client is 72.

Please confirm Nil Discount from outset is possible.I have clients chasing Doctors for GP reports.

Yes, it’s possible. It obviously means no discount and the GP report request cancelled. This is because 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 in existence when the transfer into trust is made (not after).

If underwriting has not taken place prior a nil discount is possible but it is generally better to obtain a GP report to ensure accurate underwriting.

If the total gift is over NRB but the discounted gift value is under the NRB do entry charges still apply if going in a discretionary trust?

No, entry charges apply only if the discounted gift value exceeds the nil rate band. The discounted value is used for all IHT calculations.

Does the settlor stipulate what income they want then? Or is it limited depending on the level of gift?

The settlor stipulates the income they want, within the limits of the underlying investment.

Is the difference between the total settled into trust and the ‘transfer of value’ gift, in Alice’s case £158,500, immediately outside of her estate?

Yes, the difference is immediately outside of her estate for IHT purposes.

Can you take more income than needed and use to gift from income, or is it treated as return of capital?

It is treated as a return of capital, not income.

Gifts from excess income are generally exempt, but using DGT “income” (which is capital) would not qualify for this exemption.

If a gift to a discretionary trust (via a DGT) is from excess income is it subject to tax if it exceeds NRB?

Highly unusual circumstances we would guess but f the DGT was funded by excess income that qualified for the exemption any amount could be added without an entry charge.

What happens if  a client has a DGT and WOL, is taking the DGT income as she is an additional rate tax payer?

The “income” would not affect their tax position if within the tax deferred allowance.  Paying the income into a WOL that is under trust would be a gift.

Can you put a rental property into a DGT and take the naturally produced income (assuming you need/spend it)?

In theory yes. It would be highly complex and require specialist actuarial underwriting and legal advice.

Once the Settlor has died, do you just treat it like a Gift Trust in every way?

Basically yes,  after the settlor's death, the DGT is treated like a gift trust.

The discount is at HMRC discretion so worthless (two failed on accidental early death/ suicide -  experience and upset families)- why not whole life and endowment?

The discount is not worthless.  Where there is adequate medical evidence sufficient to underwrite the settlor’s life to the standards required for whole of life assurance (with full disclosure) at the point the trust is set up then there should be no reason to refuse the discount.

Whole life and endowment policies serve different purposes and may not provide the same IHT benefits.

Is it best to use 2 separate plans for joint lives or a joint plan/trust for husband/wife/civil partners? what are the issues to recommend one or the other?

There are pros and cons, to each option. For DGTs we believe it is generally better to use two separate trusts for joint lives to provide more flexibility over payment amounts on first death and avoid complications with chargeable events and periodic charges.  Those advantages outweigh the admin disadvantages and the potentially poorer product terms having two investments.

Do HMRC have the right to question the amount of discount given? And what about health condition?

Yes, HMRC can challenge the discount amount, especially if there was inadequate disclosure during underwriting. If there is full underwriting with no non-disclosure then there should be no grounds to refuse the discount.

Does the settlor decide how much income they are going to take, or does Pru determine how much they can provide for X investment amount?

The advisor and settlor decide the income amount based on the settlor's needs, within the limits of the underlying investment (our bonds maximum regular withdrawal is 7.5%).

Can an expression of wishes from the settlor of the DGT direct the deceased's beneficiary's share of the absolute trust?

No, the expression of wishes cannot override the terms of the trust. The beneficiary's share will follow the terms of the trust or intestacy laws.

On the death of the settlor instead of deed of assignment to beneficiaries, the beneficiaries just take income and keep in the trust and outside their estate?

Yes, the beneficiaries can continue to receive income from the trust without the need for a deed of assignment.

What are your thoughts on the recipient of a Loan Trust loan using the money to set up a DGT and doubling down the potential IHT benefits + increased control?

Sorry, I don’t understand what you are trying to ask. If you contact your account manager they can arrange a discussion with one of our technical team to help us provide you with an answer.

Chargeable events - ongoing advice charge, is this deemed to be caused by the trustees and therefore not assessed on the settlor.

The Ongoing Advice Charge (OAC) is an agreement between the trustees and the adviser. Generally speaking, the withdrawal instruction to maintain the settlors rights plus the OAC are normally kept within the available 5% Tax Deferred Allowance (TDA).

There are different scenarios where this could happen.

1 - Settlors rights are within the 5% TDA when the trust is set up but the addition of an OAC by the trustees will trigger an excess gain.

We don’t believe the gain would be assessed against the settlor in this scenario.

2 – Absolute DGT or Discretionary DGT with settlors rights held on bare trust. Settlors rights and OAC are within the 5% TDA from outset but an excess gain occurs once the TDA has been exhausted e.g. at the 21 policy anniversary or beyond.

In this scenario we believe the gain would be assessed against the settlor. The settlor would only have a statutory right to recover any tax liability when it’s a discretionary DGT and it would apply to the proportion of the gain caused by the OAC only.

It should be noted that we contacted HMRC directly to seek clarification on these questions and we are still awaiting a response.

Re chargeable event in year 21 .  I understand that the policyholder is taxed but mentioned about reclaiming the tax from the Trust - can  you elaborate?

The trustees are the policyholder (not the settlor)  and will receive the chargeable event certificate. The trustees then need to determine who’s liable for the gain.

If it’s a discretionary DGT and the settlors rights are not held on bare trust then the settlor would be liable for the gain (if UK tax resident). The settlor would have statutory right to recover any tax due from the trustees. The trustees would need to take a withdrawal from the bond to make the payment to the settlor which could create another chargeable event.

If it’s a bare DGT or a discretionary DGT with the settlors rights held on bare trust, the settlor is liable for the gain but won’t have a statutory right to recover the tax from the trustees. They would need to pay the tax bill from their own resources.

Can the beneficiaries take loans from a DGT after death of settlor?

It depends on the terms of the trust but most trusts will give the trustees wide powers to invest and manage the trust fund for the benefit of the beneficiaries, including making loans to beneficiaries. If the trustees were to lend money to a beneficiary they should get a loan agreement drawn up by a solicitor to detail the terms of the loan.

Its important to clarify that OACs can create problems down the line if not a fixed % of the bond at outset. Can create chargeable events annually from year 2.

If you take partial withdrawals that exceed the tax deferred allowance in a policy year then you will have an excess gain at the end of the policy year. Withdrawals will include ongoing advice charge.

Should the settlor survive past 20 years, do you allow the bond to be "rebased" starting a new 5% allowance?

Prudential’s discretionary DGT allows trustees to surrender and reinvest the proceeds so you could rebase the bond however, you would have to take into account how any gain would be taxed on encashment. With the Prudential absolute DGT, the settlor’s rights are carved out of the bond so if the bond is encashed the settlor’s rights come to an end. This means they would receive no more withdrawals and they would be making a gift for IHT purposes. Advice would then need to sought to value the gift being made taking into account health, life expectancy and the withdrawals given up.

What are the relative merit of using onshore or offshore bond for DGT?

It depends on the tax position of the parties involved i.e. settlor and beneficiaries, and who chargeable gains are ultimately going to be assessed on. Generally speaking if gains are likely to be assessed on someone who is a non-taxpayer, offshore would be preferable. Otherwise, onshore may have an advantage however, you would need to consider the specifics of the case, the amount being invested, size of the gain etc

If a DGT is set up as an absolute trust for adult child as beneficiary, if the child gets divorced can the DGT be attacked as part of child's estate?

Yes. The beneficiary has a vested interest in some or all of the trust fund so it would be taken into account in a divorce.

Just charge client a fee without getting into uncertainty with ongoing fee?

Ongoing advice charge is paid by the trustees as it the trustees who are receiving ongoing advice. The settlor could only pay for the advice by topping up the trust (which would be a transfer of value for IHT) but not all DGTs allow for top-ups to the trust after the bond has been set up so it ay not be possible in practice.

Its the discount that is immediately outside of the estate? The gift is out side of the estate after 7 years?

The discount reduces the value of the settlors Potentially Exempt Transfer (PET) or Chargeable Lifetime Transfers (CLT). The settlor still needs to survive seven years for the reduced PET or CLT to fall out of their estate calculation.

Assuming we can change the underlying fund holdings within the bond without an issue?

Yes. Fund switches within the bond have no tax implications and do not affect the settlor's rights to future payments from the trust. 

The trust ..... do you need a trust deed drawn up by a solicitor is the Pru trust document sufficient or do you need both?

We provide a range of draft trust deeds which include a Discounted Gift Trust which advisers can use in conjunction with our onshore and offshore investment bonds for UK resident settlor(s). There is no fee for using our draft trust deeds and a solicitor is not required to draft a trust deed.

We also provide a range of supplementary deeds for common trust administration scenarios during the journey of the trust e.g. deeds of appointment, retirement or removal of a trustee.

We don’t provide legal services and there might be scenarios where a solicitor will be required to draft a supplementary deed where we don’t have a suitable draft deed available.

The settlor and/or trustees might require their own legal advice prior to using one of our draft trust deeds or during the journey of the trust.

If Trustees surrender DGT after 10 years (settlor has taken 5% pa but no longer needs income) please recap IHT position?

With most DGTs, the surrender of the bond does not in itself have an IHT impact on the settlor. The trustees would still be expected to make the settlor’s payments from the cash they hold or the investment if the money has been reinvested. With some DGTs however, particularly those which are set up on absolute basis, the settlor’s payments are carved out of the bond rather than the trust. With these trusts the settlor’s rights would come to an end on surrender of the bond resulting in a gift being made which would remain in the estate for 7 years. They would need to seek advice on how to value this gift as it would depend on health, life expectancy and level of withdrawals being given up.

Did you say that if you use the withdrawals from a DGT to fund a WOL plan they would be considered as CLTs?

If a whole of life policy is held with a discretionary trust then unless the premiums are covered by one of the gifting exemptions, the premiums would be chargeable lifetime transfers. DGT withdrawals are not income so it is unlikely they would be exempt under the normal expenditure out of income exemption. The annual exemption, if unused could be offset against the premiums but if the premiums are not exempt then they will be chargeable transfers.

Are there any objections to investing the leftover monthly income (£2,000 needed, £3,500 net monthly payment) in a Business Relief Investment, <£1M threshold?

If the settlor has unspent withdrawals from a DGT, it is up to them what they do with the money and you would need to consider whether these should be retained, gifted or invested in a business relief investment. Best practice would be to calculate the level of withdrawal that is going to be spent to try and ensure there is no such money building back up in the settlor’s estate.

I thought that you can stop the withdrawals for a DGT after 7 years, it just means that the discount is removed?

That is incorrect. If the settlor stops the withdrawals they are making a gift for IHT purposes. They would need to seek guidance from an actuary to calculate the value of the gift being made taking into account their state of health at the time and the level of withdrawals being given up.  

Can a DGT in discretionary trust have the settlor as the life assured of the bond?

We have had Counsel opinion on our own Discounted Gift Trust on this subject and it was confirmed that having the settlor(s) as a life, or lives, assured would not constitute a gift with reservation.  

Is there a way to allow for rising returns of capital to the settlor? (to account for rising costs of living etc)

There is nothing to stop an indexed payment being set up from a technical perspective but it will depend on the terms of the trust being used. It’s relatively uncommon to see indexed payments on DGTs as most providers offer fixed payments.

Can you recap the life assured bond slide saying the gain will be wiped on settlors death? My understanding was the gain/tax paid is assessed in the TYE of DOD?

The example used was a discretionary discounted gift trust. You are correct that with a discretionary trust, if the gain arises within the trust in the tax year of the settlor’s death the gain is assessed on the settlor with any tax due being reclaimed from the trust (assuming the settlor is UK resident).

On the Case study regarding Adviser's OAC, wouldn't it be better to have the fee paid by the Settlor, instead of using some of the Tax Deferred 5%?

Ongoing advice charge is paid by the trustees as it the trustees who are receiving ongoing advice. The settlor could only pay for the advice by topping up the trust (which would be a transfer of value for IHT) but not all DGTs allow for top-ups to the trust after the bond has been set up so it ay not be possible in practice.

Can we use an existing pru bond as for DGT?

No. Prudential’s discounted gift trust must be set with a new bond.

Can you take funds out of the DGT discretionary trust to pay a periodic chargeable event?

Yes. It is the trustee’s responsibility to pay the periodic charge so they need to use some of the trust property to do so.

With an absolute DGT, should the beneficiary get divorced, does the settlors entitlement still outstrip the right of the spouse to 50% of the entitlement?

It would depend on what the court decided however our understanding the settlor’s rights would still take precedence so the beneficiaries would need to wait to receive their entitlement from the trust fund.

If a settlor is taking 4.5% and the OAF is 0.5% pa, no chargeable event occurs. However, if a periodic charge of £4,000, how is this payable?

The trustees would need to take a withdrawal from the bond which would trigger a chargeable event if taken as a partial (exceeding the 5% tax deferred allowance), segments are surrendered or a combination of segments and a partial.

Could it be viable to re-broke the DGT after 20 yrs and once the client has had full return of original capital, I understand this would need approval by Trustees?

The trustees are the client. It’s possible with a discretionary DGT but would not be appropriate for an absolute DGT as surrendering the bond would terminate the settlors rights and give rise to a Potential Exempt Transfer by the settlor. We cover the considerations in our DGT - changing the underpinning investment article.

Are the rules for chargeable events the same for all trusts? e.g. Discretionary Gift trust with offshore bond. Settlor waives his right to the asset and eight years later the beneficiaries surrender. Who is responsible for income tax due? (settlor is still alive)

They are broadly the same but there are exceptions when it’s an Absolute Discounted Gift Trust or where the Parental Settlement Rules apply. We have decision trees in section four of our Important Information about Trusts guide which you should find helpful.

When calculating the periodic charge I assume the settlors withdrawals disregarded when calculating the end value in year 10?

Correct

Please confirm where BR qualifying assets sit in the IHT calculation?

Business Relief (BR) qualifying assets are included in the net estate, the relief available is then deducted later on in the calculation when arriving at the taxable amount before any NRBs.

Because your BR assets are always in your estate that’s the reason BR eligible investments can make you lose RNRB.

Who pays the 6% tax on discretionary trusts?

The trustees are responsible for paying the 6% tax on discretionary trusts.

Can the periodic charge be taken from the bond itself or does the client need to settle it using cash?

The periodic charge can be taken from the bond itself. Where the trust conditions allow a further gift could be made by the settlor to pay the charge.

How is a periodic charge actually paid by the trustees with no trustee bank account etc?

The periodic charge can be paid through a trustee's personal account, preferably not the settlor's account, with a clear audit trail.

May be mentioned in presentation but need clarification if it is true IHT for AR can be paid over 10 years?

Yes, IHT for Agricultural Relief can be paid over 10 years. 

Periodic charges - do the Trustees potentially create a further tax charge (CEG) for withdrawing funds from the bond to pay the charge to HMRC?

Yes, it’s possible the trustees will trigger a chargeable event for tax purposes. It will depend on the position of the bond. If there’s sufficient unused tax deferred allowance available they might be able to take a withdrawal without trigger an excess gain.

Hi, If max out £325k CLT with discounted gift, how is WOL in Discretionary Trust taxed, say £12,000 annual premium?

I assume you are referring to single settlor trusts here. If so, unless the premium was exempt it would be a chargeable lifetime transfer and would suffer an IHT entry charge. Assuming no surplus income (a DGT wouldn’t be set up for someone who had surplus income) then the only other exemption which could apply would be the £3,000 annual exemption (if it was unused elsewhere). If the annual exemption was available then £9,000 of the premium would suffer an immediate 20% IHT charge for which the trustees would be liable. If the settlor were to pay the charge this would be grossed up to 25% i.e. 9,000 x 25% = £2,250

Also, you mentioned that the capital put in the business property relief is still included in the calculation for RNRB?

Yes, reliefs are deducted for calculating IHT due on the estate but not for the purposes of working out the RNRB taper.

Can the rysaffe principle be used to help avoid periodic charges on a DGT set up on a discretionary basis?

Yes but it wouldn’t have a significant impact. Assuming no other gifts, the first trust would have a full nil rate band for the periodic charge however each subsequent trust would have a reduced nil rate band due to the chargeable transfers into the trust(s) set up previously.  

Will you be mentioning order of trusts as sometimes done at similar time as Loan trust?

There wasn’t enough time to cover in today’s session but you should find our Order of Gifts article and 14-year rule video helpful.

Since the gift has been in effect for over 5 years, is it still considered part of the estate, and does it incur an income tax liability?

Yes, the Potential Exempt Transfer or Chargeable Lifetime Transfer will be included in the settlors estate calculation if they die within seven years.

Whether an income tax liability arises on the bond and who will be liable for the gain will depend on the circumstances. For example, if the settlor is the sole or last remaining life assured on the bond, their death would automatically trigger a chargeable event. If there is a surviving life assured on the settlors death or it’s an offshore bond on a capital redemption basis there won’t be an automatic chargeable event on the settlors death.

Who’s liable for the gain should one arise automatically on the settlors death or if surrendered by the trustees in the tax year of the settlors death or later will depend on whether it’s an absolute or discretionary trust. There are too many permutations to cover here, but you can assess the position using the decision trees in section four of our Important Information about Trusts guide.

Alternatively, if the bond doesn’t automatically end on the settlors death, it’s common for trustees to assign segments of the bond to trust beneficiaries post the settlors death. The beneficiary would then be liable for any subsequent chargeable event gains realised on their segments at their own marginal rate.

 

Does it make a difference if one of the settlors in a couple is not UK domicile? I have a couple where one is USA but he is applying to become a UK citizen?

This situation requires specialist advice due to the complexities of cross-border tax implications and domicile rules.

Discretionary trust/divorce - have read articles that judge can request trustees consider making an appointment so it's included - your thoughts on this? 

Yes, a judge can request trustees to consider making an appointment, and trusts can be attacked in divorce proceedings.

Re BR being retained within the estate, can it be written under a discretionary trust?

Yes, is it possible to place qualifying business relief investments into trust.

What are the implications if there is more than one trustee and one of them relocates abroad?

It depends on the specific case and the countries involved. You need to consider the tax residence of the trust from a UK perspective to see if it will be considered a UK resident trust and this could be impacted by a trustee moving away from the UK. This article explains how to establish whether a trust is UK resident or not. 

It could also have tax and/or reporting implications in the new country so the trustees would need to seek cross border tax advice in order to understand the full implications.

Disabled persons trust held in an offshore bond 20 yrs on 5% pa taken. Is tax assessed against the sole beneficiary or the Trustees, ? is top slicing available?

You would need to read the trust deed to determine who would be assessed on any gains rising with the trust. We have an article which discusses qualifying trusts for vulnerable beneficiaries in more detail. 

For a discretionary trust, what's the best practice for the trustees stating the current beneficiaries?

The settlor should write a “letter of wishes” outlining how they wish the trust fund to be administered and give this to the trustees. The letter is not legally binding but it does give the trustees an understanding of the settlor’s wishes.