Background
Eleanor and Felix, a couple in their mid-sixties and early sixties, respectively, are happily married with five children, several grandchildren, and possibly more on the way. They are both in excellent health and anticipate living for at least the next seven years. After moving to a smaller home, they now have a substantial amount of savings in their bank accounts and are aware that there might be an Inheritance Tax (IHT) issue upon their second passing. They haven't made any major donations before. They aim to reduce the IHT but are mindful that their everyday spending needs are higher than what their pensions can cover. Instead of giving away large sums to their family now, they simply wish for their loved ones to receive benefits after they pass away.
Advice
Eleanor and Felix -
- A potential Inheritance Tax issue that must be resolved.
- Wealthy in assets but lacking in earnings.
- Need to increase their standard of living.
- In good health and younger than 90.
- Eligible individuals can still gain advantages following the second death. FOL WEALTH suggests that they should set up a discretionary Discounted Gift Trust (DGT), detailing - • This is suitable for those facing an Inheritance Tax (IHT) obligation yet wish to retain complete control over their assets.
- Each is granted access through a sequence of predetermined capital contributions.
- Every individual can select how much they want to pay and how often.
- By examining their expected earnings and spending, we can determine the necessary payments.
- The phrase "discounted" is employed because the initial value of the trust is less than the total investment.
- As long as they remain in good health, they will be eligible for the discount, which will be immediately accessible to their estate.
- Their individual discounted gifts will be well below £325,000, ensuring they do not incur a lifetime 'entry' fee associated with the Chargeable Lifetime Transfers (CLTs)
- Should either of them be older than 90 or have a rating, the discount would be very small.
- The two flexible trusts provide the option to adjust for individuals who might receive the leftover assets following the settlor's passing. This could include future grandchildren (and great-grandchildren).
Outcome
Eleanor and Felix learn that a gift into a DGT is a transfer of value where the value is determined by the ‘loss to the estate’. That will comprise the amount invested less the value of the right to the repayments (see below). The open market value of these repayments depends on age, health and size of the repayments.
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FOL WALTH explains that HMRC’s preference is that full underwriting should be carried out prior to the DGT being effected. The actual amount of the discount may need to be ultimately agreed with HMRC, but the Insurance Company offers an indication of the value at inception based on medical evidence provided.
Both Eleanor and Felix apply for a UK Insurance Bond on a single owner, single life basis. Each then completes a DGT deed. In their deed, each selects the size of the payments and the frequency (e.g. monthly, quarterly etc.). In both cases, the withdrawals selected are within 5% limits, even accounting for ongoing adviser charging. Assuming no shortfall, both have the right to these regular payments for life, and on death that right ceases and so does not swell the value of the deceased’s estate. The trustees then have the discretion to distribute the remaining capital to any of the class of beneficiaries. This includes children and remoter descendants but excludes the settlor.
The surviving spouse is however a potential beneficiary. What this means is that when one of them dies, the survivor will still enjoy the regular payments from their own DGT but in addition, the trustees of the first deceased’s DGT have discretion to advance any remaining funds to the survivor should that need arise. Trustee obligations under the Fourth and Fifth Money Laundering directives are complied with.
FOL WEALTH Investment Bond Advice London explains that it would have been possible, instead, to have set up a joint DGT and in that event the total joint repayments would have continued after first death, and simply ceased after second death. That would be less flexible, but would probably have created a bigger discount.
FOL WEALTH Investment Bond Advice London however clarifies that the main objective of the DGT is to mitigate IHT and carve out access to pre-determined capital payments for expenditure needs. Although the discount provides an immediate reduction in the estate, it is only relevant for death within seven years – both however are in good health.
They discover that it doesn't make sense to use up all the set-up funds just to get a bigger discount. If a settlor uses more funds than necessary for spending, it might not be a good move for the overall goal of reducing IHT, as the extra money will end up in the estate.
When one spouse passes away, the debt in their DGT will be settled if the deceased was the only person guaranteed. The taxable gain will be reported on the deceased's tax return for that year. Since their income is quite low, it's expected there won't be any tax liability, and the money can then be used as the trustees wish.
Summary
Eleanor and Fred are establishing a tax-efficient plan that promises consistent, predetermined payments for life, which they need to supplement their earnings. They can immediately receive a reduction in Inheritance Tax due to the fact that the initial value transferred to set up the trust is less than the total amount invested. Upon the first death, the surviving spouse can enjoy any remaining assets in the deceased's trust, subject to the trustees' discretion.
Please note that this is merely a general example and not tailored to the specific situations of your clients. The needs, circumstances, and tax situations of each client will differ.
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