Discounted Gift Trusts (DGT)

The term ‘discounted’ is used because the value transferred on establishing the trust is less than the amount invested. The settlor is typically entitled to payments on specified dates subject to if alive on those dates. The settlor's transfer or gift is the bond/policy premium less the value of the payments receivable during his/her lifetime.

The starting point is to estimate the settlor's life expectancy. This is done through an underwriting process. Once the settlor's life expectancy has been established the value of the payments receivable during his/her lifetime is calculated and reduced to current values by use of a discount factor (a reverse interest rate). An adjustment is made for various costs. The value of the settlor's entitlement is deducted from the premium to give the value transferred.

Nil or negligible discount is available where the settlor is, or is ‘rated’ over 90. The value transferred in such cases is broadly the policy premium.

The trust is typically established by the settlor making a cash gift to the trustees. It isn't normally possible to use an existing bond or other investment to create the trust - these will generally need to be encashed and the proceeds used to establish the discounted gift trust.

The trustees then invest the trust funds by taking out an investment bond (onshore or offshore). Regular withdrawals are set up to provide the settlor's capital payments.

Payments from the trustees to the settlor in a DGT are capital, not income.

There are two basic types of DGT, but many variations on the general DGT theme.

Those based on a bare/absolute trust structure and those based on a discretionary trust structure.

Use of a bare/absolute trust structure triggers an IHT potentially exempt transfer (PET) by the donor. The trust fund is within the beneficiary's IHT estate. (In this context the trust fund is the policy/bond value less the value of the settlor's rights to payment.)

Use of a discretionary trust structure triggers an IHT chargeable lifetime transfer (CLT) by the settlor and the trustees are thereafter within the relevant property regime. The discretionary structure gives greater flexibility.

Joint settlor versions of both structures are widely available.

In a bare/absolute structure, where a chargeable event gain arises in the tax year following that in which the donor dies, the gain is chargeable on the individual who owns the rights under the policy. That individual will be the named beneficiary.

For chargeable events arising during the donor’s lifetime or in the year of the donor’s death, both donor and beneficiary have a material interest in rights (of a different kind) and so gains are attributed in accordance with their share of the rights on a just and reasonable basis:-

1) Donor is alive and regular withdrawals breach 5% allowance.

• Regular withdrawals are considered part of surrender of rights. If a gain has arisen, it has arisen because of the regular withdrawals (and only the donor holds the right to such withdrawals) and any gain will be assessable on the donor.

2) Donor is alive, regular withdrawals do not breach 5% limits, but a chargeable event gain arises as a result of the trustees making an ‘emergency’ advancement of trust capital to a named beneficiary (without reducing the value of the donor’s rights).

• The gain in this case is the sum payable as a result of a right (and continuing right) under the policy. This is a right held by the beneficiary only, and so they will be assessable on the gain.

3) Donor dies and is the sole life assured (or donor dies and bond is encashed in the tax year of death).

• If the donor’s only right is the right to regular withdrawals, and this right is terminated on death then it is reasonable to assume that any gain arising after the date of death is likely to be considered a transfer of income/capital to the beneficiary only. Unless a regular withdrawal was made before death, or to the estate after death, then it would be reasonable to assume the gain would be wholly attributable to the beneficiary.

In a discretionary trust structure, chargeable event gains arising on the trustees' bond/policy will be assessed on the settlor whilst alive and UK resident and thereafter, in tax years after death, on UK trustees.

• May allow an IHT-effective transfer immediately from an individuals estate

• Allow settlor access through preselected payment stream

• May attract a discount for IHT purposes

• Tried and tested method

• Relatively inflexible

• Payment stream can't be changed

• Payments generally capped so as not to exceed the 5% rule

DGTs don’t trigger the reservation of benefit provisions because the settlor's rights are never given away. The settlor's gift to the trustees is subject to the pre-selected payment stream, the right to which is never given away.

The settlor's contingent right will have no value on death. There is nothing to be included in his/her estate in respect of the payments.

The operation of a DGT should not trigger an income tax charge under the POAT regime.