How a Discounted Gift Trust Benefited the Thompson Family
Remove the inheritance tax guesswork!
Case Studies:
The Thompsons’ Situation:
- Combined estate value: £2,000,000
- Desired legacy for children: As much as possible
- Need for regular income: £20,000 per year
- Main concern: Reducing IHT liability without losing financial security
The DGT Solution:
After consulting with our experts, the Thompsons decided to set up a DGT with the following details:
- Amount placed in trust: £500,000
- Trust type: Discretionary
- Beneficiaries: Their two children
- Withdrawal rate: 4% per annum (£20,000)
The Benefits:
Immediate Reduction in Estate Value
- Initial gift value: £500,000
- Discounted value for IHT: £350,000 (based on their age and health)
- Immediate reduction in taxable estate: £150,000
Ongoing Income
The Thompsons receive £20,000 per year from the trust, maintaining their lifestyle.
Potential IHT Savings
- Immediate IHT saving: £60,000 (40% of £150,000)
- If they survive 7 years, additional IHT saving: £140,000 (40% of £350,000)
- Total potential IHT saving: £200,000
Flexibility for the Future
As a discretionary trust, they can change beneficiaries if needed.
Investment Growth
The remaining trust assets can grow free of additional IHT.
Long-term Impact:
Assuming the Thompsons live for another 15 years and the investments grow at 5% per annum (after charges and withdrawals):
- Value of trust after 15 years: Approximately £640,000
- Total income received over 15 years: £300,000
- Total IHT saved: £200,000 plus IHT on any growth (potentially another £56,000)
The Outcome:
By using a DGT, the Thompsons were able to:
- Reduce their taxable estate immediately
- Secure a regular income for their retirement
- Potentially save their children over £250,000 in inheritance tax
- Provide a growing pot of money for their children’s future
Case study demonstration
This case study demonstrates how a DGT can be an effective tool for balancing the need for current income with the desire to reduce inheritance tax liabilities. However, it’s important to note that each situation is unique, and professional advice is crucial to determine if a DGT is right for you.
Remember, while DGTs can offer significant benefits, they also come with complexities and potential risks. Always seek professional advice to ensure you’re making the best decision for your circumstances.
Frequently Asked Questions About Discounted Gift Trusts (DGTs)
How does a DGT affect my inheritance tax?
A DGT can reduce your inheritance tax (IHT) liability in two main ways:
Immediate reduction: When you set up a DGT, the value of your gift is discounted for IHT purposes. This discount is immediately removed from your estate, potentially reducing your IHT liability.
Seven-year rule: If you survive for seven years after setting up the trust, the entire gift (not just the discounted portion) falls outside of your estate for IHT purposes.
For example, if you place £100,000 in a DGT and it’s discounted to £70,000, your estate is immediately reduced by £30,000 for IHT purposes. If you survive seven years, the full £100,000 is removed from your estate.
Can I add to a DGT after it’s set up?
Generally, you cannot add to an existing DGT after it’s set up. Each DGT is based on a single premium or lump sum contribution made at the outset. This is because:
The discount is calculated based on your age and health at the time the trust is established.
Adding to the trust later would require a new underwriting process and a new discount calculation.
If you want to contribute more, you would typically need to set up a new DGT. This new trust would be treated as a separate arrangement with its own discount calculation and seven-year clock for IHT purposes.
What happens to a DGT after death?
When the settlor (the person who set up the trust) dies, several things happen:
Regular payments cease: The income payments to the settlor stop.
Trust continues: The DGT doesn’t automatically end. It continues to run according to its terms.
Beneficiaries: The remaining trust fund is held for the beneficiaries. How and when they receive it depends on the type of trust:
In an absolute trust, the beneficiaries become entitled to their share.
In a discretionary trust, the trustees decide how to distribute the assets.
IHT implications: If the settlor dies within seven years of setting up the trust, the gift (minus any discount) may be subject to IHT.
If the settlor survives seven years, the entire gift is outside the estate for IHT purposes.
Potential periodic and exit charges: If it’s a discretionary trust, it may be subject to periodic and exit charges, depending on the value of the trust.
How are DGTs valued?
DGTs are valued using a complex actuarial calculation that takes into account several factors:
- Settlor’s age and health: The younger and healthier the settlor, the higher the discount, as they’re likely to receive payments for longer.
- Amount of the gift: The total amount placed in the trust.
- Withdrawal rate: The amount of regular payments the settlor will receive.
- Investment growth assumptions: Projected growth of the invested assets.
- Mortality tables: Actuarial data on life expectancy.
The valuation process typically involves:
- Calculating the present value of the settlor’s right to receive regular payments (the ‘carved out’ portion).
- Subtracting this from the total gift to determine the ‘discounted’ value.
- For example, if you gift £100,000 and the carved out portion is valued at £30,000, the discounted gift would be £70,000.
- It’s important to note that this valuation is carried out by actuaries and is specific to each individual case.
- The exact methodology can be complex and may vary between providers.