How discounted gift trusts can help mitigate IHT

What is a discounted gift trust?

A discounted gift trust is a type of trust in which the settlor (or settlors, if the account is jointly owned) is allowed to give away a portion of their financial assets while still enjoying regular retirement payments for life. 

If you are in a higher tax bracket, using a discounted gift trust can be an effective way to mitigate IHT, which has tripled since 2010. 

This kind of gift trust enables settlors to move investable capital outside of their estate without relinquishing the right to draw a regular income from it. The value of the settlor’s gift for inheritance tax is then discounted by the value of those future retained payments, thus allowing them to maintain their right to pre-agreed payments for life. 

Discounted gift trusts also ensure beneficiaries retain the right to their trust fund after a settlor’s death. 

How does a discounted gift trust work?

Discounted gift trust can be set up as an absolute or discretionary trust. 

Which one your client chooses should depend on a variety of factors, such as: 

• The level of flexibility the client needs in changing or adding beneficiaries.
• How settlors and trusts will be treated for IHT tax purposes.
• The level of control settlors want to give beneficiaries. 

By putting a client’s financial assets into a discounted gift trust instead of leaving them in a regular trust, they can reduce liability to IHT and sometimes even receive an immediate reduction in the value of their estate. 

How do discounted gift trusts help mitigate IHT?

When it comes to passing down generational wealth, subjection to IHT is high, particularly if a settlor’s net worth is at the higher end of the spectrum. This can lead to costly IHT that reduces estate trusts and limits the amount of withdrawals settlors can make from their retirement funds. 

But by carrying a portion or several of that fund into a discounted gift trust, settlors can maintain control over their assets while still drawing from them as needed at a slightly discounted rate. This helps mitigate IHT while still allowing settlors to access their estate funds. 

What is a trust structure & how do they work?

A trust structure is a legally binding arrangement that requires three elements: a trustee, trust property, and beneficiaries. 

The trustee is responsible for managing and distributing the trust fund, and the beneficiaries are the heirs or individuals to whom the assets have been bequeathed.

Discounted gift trusts are one of several trust structures available. When it comes to this IHT-mitigating type of trust structure, there are three different types to consider:

1. Bare or absolute trust structure

Bare is traditionally used to pass assets to young people. The assets within this trust are held in the name of a trustee and can be accessed once the beneficiary is 18. Once beneficiaries are listed, they cannot be changed or revoked. 

2. Discretionary trust structure

Under the discretionary trust structure, the distribution of assets occurs only at the discretion of the trustees, not the beneficiaries or anyone else. 

Trustees can list beneficiaries less specifically, such as “my grandchildren,” as opposed to exact names, making it a more flexible trust structure plan. 

Gifts within discretionary are considered chargeable lifetime transfers, exposing them to an immediate 20% IHT charge. 

3. Interest in possession trust structure

With interest in possession trusts, the trustee must pass on all trust income to the beneficiary as it arises (less any expenses). For example, you can bequeath the income from shares you own to a beneficiary but not the shares themselves. 

Are IHT receipts on the rise?

Government-issued IHT receipts are indeed on the rise. Between April 2021 and March 2022 alone, the HMRC accrued over £6.1bn in IHT payments, which was a £0.7bn increase from the previous 12 months. 

Since 2010, the amount of IHT receipts has more than tripled. This trend is likely to continue its uptick in the coming years. 

What are the main considerations surrounding discounted gift trusts for clients?

There are a few key considerations clients should keep in mind when contemplating discounted gift trusts. 

The main ones include how much flexibility a client wants around changing beneficiaries before their death and how much control they are willing to give over to those beneficiaries. 

Net worth and estate worth are also important considerations as only settlors with an estate worth over £325,000 are likely to benefit from discounted gift trusts. 

Want to work with Unbiased?

Knowing how to mitigate IHT and help clients create discounted gift trusts is an important function of any financial adviser in the UK. 

Not only can it reduce a client’s inheritance tax liability by removing value from their estate, but the settlor also still retains access to capital via regular withdrawals. This benefits both the settlor and those who stand to inherit. 

If you want to grow your business sustainably, join Unbiased Pro for access to clients who need the financial services you offer.