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What is a Discounted Gift Plan and Why Use One?

A personal favourite – representing one accepted means of “having your cake and eating it” for Inheritance Tax purposes (IHT).

A DGP is suitable for someone with a large enough personal estate to be facing the prospect of IHT liabilities when he/she dies, who also has access to lump sums that can be invested, essentially liquid assets.

40% IHT rates mean that DGP’s are worth serious consideration.

The taxpayer will be able to receive an income from the plan, but must be comfortable with not having any requirement to get access to the capital invested.

To gain maximum tax benefits, he/she must also be willing to decide who will be the beneficiaries of the investment on the basis that he/she cannot later change his/her mind – a “fixed interest” scheme.

Essentially the DGP comprises the following steps:

  • The taxpayer decides on how much to invest (often by reference to what income he/she wants back out of the scheme)
  • Most of this investment is held by a special trust which is usually managed by a life assurance company under its own documents that are specific to their DGP scheme.
  • The life assurance company works out (by its actuaries) the capital value of the income repayments the taxpayer wants out of the scheme.
  • This “capital value” is then deducted (or if you prefer, “discounted”) from the total of the capital sum the taxpayer has invested in the DGP.

So, what does this achieve?

1.            The taxpayer has given away a lump sum in exchange for an income which is worth less, so the taxpayer’s estate is reduced by the difference. The reduction in the value of the taxpayer’s estate is with immediate effect – no need to worry about waiting 7 years.

2.            The discounted capital value of the income from the plan has not been “gifted” away by the taxpayer, but is rather a commercial exchange of capital for income.

3.            As to the balance in the scheme, (if you like the “undiscounted” part of the investment) held for the taxpayer’s beneficiaries, this is a “potentially exempt transfer” for IHT purposes, and provided he/she survives 7 years, this too will escape IHT.

The levels of IHT saving that can be achieved will be affected by the age and health of the taxpayer at the point of entering a DGP, and the tax implications are different if a taxpayer does not want to fix who the beneficiaries are at the outset.

To illustrate how IHT may be saved with a “fixed interest” DGP.

Investment Sum        Taxpayer Male – Aged             “Discount”                        Max IHT Saving             

£250,000                                 60                                           £140,000                              £56,000             

 Naturally, professional advice is a must. DGP’s are marketed widely by insurance companies and will be individually underwritten and of course should also be tailored to your specific needs.

Lifetime Asset Protection Trusts

Sounds impressive, but you need to be on your guard in relation to any arrangements that are offering a silver bullet to deal with preserving your assets, especially in the context of attempts to ring-fence your house against potential charges to Care Home fees.

The question often asked – how do I ensure my children get my hard earned capital, which is usually locked up in the value of a person’s home?

Schemes are widely and aggressively marketed, but often they have the seeds of their own destruction in their accompanying literature and promotional material.

The vast majority involve the use of a lifetime trust into which a taxpayer (and spouse) transfer their interest in his/her own home with vague and unconvincing statements about the purpose of doing so – they wish to resolve all future matters about the succession to their assets, they wish to be relieved from the worry and anxiety of the upkeep of their home, etc.,

Because of course the taxpayers need their home to live in, they cannot be excluded from any benefit under the trust.

For Inheritance Tax (IHT) purposes, the taxpayers will technically be making a gift (into the trust) with a reservation of benefit. In effect, the fact that the taxpayer still benefits from the arrangement means that there are no IHT advantages to it, because if the taxpayer dies he/she will be treated for IHT purposes as if the value of the property were still part of his/her estate.

Furthermore, apart from that IHT downside, are taxpayers also advised that when they enter into a scheme like this, they will be giving up potential valuable reliefs for IHT, the relatively new (from April 2017) “Residence Nil Rate Band” (RNRB)?

This relief is now worth potentially £175,000 (can be double if a transferable relief is available between spouses/civil partners) but is restricted to situations where someone’s residence or interest in a residence is “closely inherited”.

If a taxpayer has placed his/her house into a lifetime trust, perhaps intending to pass it on to children in due course, then this will take place through the medium of the trust and not by inheritance – the taxpayer has nothing he/she can give on death, and the RNRB(s) will be lost – the maximum loss to your estate at current 40% rates of IHT could be as much as £70,000 if one RNRB, and if both are missed out on then £140,000.

Local Authorities are increasingly vigilant and instructed to ensure people are not rewarded for trying to avoid paying their assessed contributions to care costs, and they have wide powers to treat people as still having capital which they have deliberately deprived themselves of, plus powers to set aside arrangements (trusts or other types of arrangement) by court application if made in an attempt to put assets beyond the reach of Local Authorities.  

In short, such arrangements are wholly unattractive, especially where the trust incurs a lifetime charge to IHT (20%) because the values are above the taxpayers’ available personal Nil Rate Bands, and they cannot be dressed up artificially as tax planning.

Moral of the story – get independent and non-partisan advice before committing to such a scheme. Consider using Wills to put some structure in place that can legitimately safeguard your assets and pass them (on death) to your children.

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