Since October 2024’s budget, Inheritance Tax planning is a hot topic. It’s predicted that Britain’s baby boomers – born between 1946 and 1964 – will pass on wealth into the trillions to next generations over the coming years. The demand for advice in this area is only likely to grow.
Financial planning often requires the careful balancing of several factors: The need for income verses capital; long-term returns verses access to funds; living for today balanced with financial security tomorrow; and looking after yourself whilst also providing for next generations.
A Discounted Gift Trust can be a very useful tool in this balancing act.
What is a Discounted Gift Trust?
Structured as an Investment Bond (onshore or offshore) in trust, a Discounted Gift Trust offers a way of gifting capital to loved ones whilst retaining the right to receive a lifetime ‘income’ (technically capital withdrawals). This security of income can be attractive, particularly because a barrier to passing on wealth is often the fear of running out of money, which can lead to too little being done, too late.
To further explain a Discounted Gift Trust, the analogy of a cake is useful. Capital is gifted into a trust via an Investment Bond. This gift - the cake - is subject to the usual seven-year Inheritance Tax rules. However, a slice is removed from the cake. This slice - the discount - is the capitalised amount calculated to provide lifetime withdrawals. The slice of cake is not part of the gift but rather is a discount to the gift. The slice falls outside the taxable estate from day one, offering an immediate Inheritance Tax saving.
There are two main types of trust to choose from: Discretionary or Absolute. Beneficiaries of the trust are selected and trustees chosen to ensure capital is invested and ultimately distributed as wished and intended. The money within the Investment Bond can be invested in stocks and shares, bonds and other assets with the aim of providing a suitable long-term return.
The ‘income’ drawn from the Discounted Gift Trust is technically withdrawal of original capital. Provided that the withdrawals are 5% a year of the original investment or less, there should be no income tax or capital gains tax to pay. The investment growth within the bond will become subject to tax once in the hands of the beneficiaries.
Things to consider
Age and health are a consideration. The discount is medically underwritten and, for those in poor health, the discount offered could be significantly reduced, thus limiting the immediate Inheritance Tax saving.
A further point to consider is lack of flexibility. Once the arrangement is set up, amounts greater than the fixed lifetime income cannot be drawn, and so it is key to ensure that sufficient capital is set aside in other arrangements for easy access.
When to use a Discounted Gift Trust?
A Discounted Gift Trust is a powerful estate planning tool that provides both Inheritance Tax benefits and financial security. For those who are prepared to gift a portion of their capital, a Discounted Gift Trust can be an excellent way of striking the right balance between passing wealth to next generations, whilst keeping a stable and secure tax efficient income.
It is important to seek financial advice before setting up a Discounted Gift Trust, which can often be used in conjunction with other estate planning strategies.
Disclaimer
The information provided is for general information only and is not intended to address the particular requirements of an individual or business. It does not constitute any form of advice or recommendation by Menzies Wealth Management Ltd and should not be relied upon by individuals in either making or refraining from making any financial decisions. Where necessary, you should seek appropriate professional advice before acting on any of the information provided.
Past performance is not necessarily a guide to future performance. The value of investments and the income derived from them can go down as well as up. Investors may not get back the amount they invested.
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