Discounting your inheritance tax estate
TAX is a funny thing. Most of us are content paying our way, only if it is used wisely at the other side. I won’t open that can of worms here.
Inheritance tax is one tax many of us feel to be unfair. Having paid income tax through the years, plus countless further taxes (insurance premium tax, car taxes, national insurance, car parking at hospitals that weren’t there before) our families’ estates are then clobbered with a 40 per cent hit at a very emotional time.
One of the difficulties is giving away assets when we don’t know a range of future variables.
For example: “Will my children get divorced and I have to endure watching an annoying ‘ex’ of my daughter sail into the sunset with my money? How long will I live and need the money for? How much do I give, and to who, and when?"
One potential solution of the many available is a discounted gift trust. You don’t wish to lose control/access of your money but you need to get it out of the estate as all its growth is causing even greater problems.
Gifting, but retaining an interest, is called a gift with reservation which fails as a gift as far as the revenue is concerned and the assets return to the estate and are fully valued for inheritance tax.
With a discounted gift trust, we transfer capital into a trust for the future benefit of beneficiaries. It is set up for a series of payments to come back to the person who set up the trust (settlor). After seven years, the initial gift is outside the estate and all growth on the capital from the outset of the trust is also outside the estate.
From the beginning, the settlor is therefore entitled to an ongoing return from the trust but with the aforementioned two tax breaks. It’s sort of, ‘having your cake and eating it’ too.
One of the largest benefits, however, is that the initial gift you make is immediately discounted by the right you have to capital coming back to you. The younger you are, the greater the discount as the longer you are expected to live. The revenue have a manual on their website detailing examples of how it works but in short it goes something like this:
A couple, aged 80, transfer £100,000 into a trust. There is an actuarial calculation to ascertain how long they are likely to live, and therefore, the potential value of ‘income’ coming back to them. It is assessed as £46,300, so the actual gift from day one is just £53,700, an immediate saving to the estate.
And so, we can see that the discount heavily revolves around both the age of the settlor and the amount they wish to retain as an ‘income’. The more you retain, and the younger you are, the larger the initial discount to the estate.
The Revenue’s view now is that there is negligible discount to an over 90-year-old, but they would still potentially gain from the gift being outside of the estate after seven years alongside its growth. In reality, there are better options available for someone of that age.
The mechanics of a discounted gift scheme are well established and shouldn’t be caught by DOTAS (disclosure of tax avoidance schemes) because of those long established rules. It does what it says on the tin, and is tried and tested.
There are two types of trust that can be used (bare/absolute trust or discretionary trust), which create different outcomes, but your independent financial adviser (IFA) will take you through that, as space prohibits here.
Downsides are that the ‘income’ cannot be changed, and once set up is reasonably inflexible.
Many insurance providers offer such schemes and your IFA will know who offers the best terms. Charges within the trust and funds available to invest into, plus the choice of funds available, are everything and a good IFA will know where to go.
There is no point in saving 40 per cent tax to lose it on poor investment management . . .
:: Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a question on inheritance tax or a discounted gift trust, call Darren McKeever on 028 6863 2692, email firstname.lastname@example.org or visit wwfp.net.