Discounted Gift Trust
A Discounted Gift Trust (DGT) scheme is a lump sum investment with fixed regular income payments that immediately lifts part of the investment outside an individual’s estate for IHT purposes. An initial investment is made which is assigned to a discounted gift trust. Usually a discretionary trust is used to achieve the IHT mitigation by setting aside part of the capital for the benefit of the Settlor’s heirs.
It works as follows:
The trust creates two notional funds, the “Settlors” fund and the “Residuary” fund. The Settlors fund is retained absolutely for their benefit and is the discounted value of the expected income payable for the remainder of the Settlors lifetime. This sum or “discount” as it is referred to falls outside of the Settlor’s estate and results in an immediate reduction in the value of the Settlors estate for calculating Inheritance Tax.
The residuary fund is the balance of the premium after deducting the value of the Grantee’s fund. This is classed as a chargeable lifetime transfer for IHT purposes and will fall outside the Settlor’s estate after 7 years. Within this period IHT may apply on a reducing scale.
All investment growth on the two notional funds will be free of IHT provided that the trust fund value does not exceed the nil rate band (NRB) at each 10 year anniversary. It is important to note that the trust obtains its own NRB for the purposes of determining whether there is a 10 year periodic charge, these are applicable to all chargeable lifetime transfers every ten years for the remainder of the trusts existence.
The periodic charge is levied at 6% of the value of the trust above the nil rate band applicable at the 10th and every subsequent 10th anniversary. This charge cannot be met from the funds held in the trust. Sensible planning would therefore dictate that non-related trusts are established.
Gifting into a DGT is an irrevocable gift. Once the capital has been invested the Settlor cannot access the fund other than the “income” it provides. This is because, in order to be effective for IHT purposes, the investment treated as an outright gift from the start.