Discounted Gift Trusts Guide for Advisers – Your Questions Answered

What is a Discounted Gift Trust?

A Discounted Gift Trust allows a sum of money to be gifted to a chosen beneficiary or beneficiaries.

Your client can take annual withdrawals from the HSBC Life Onshore Investment Bond, typically up to 5% of the total amount invested.

Why consider a Discounted Gift Trust?

The Discounted Gift Trust can help with your client’s Inheritance Tax planning and mitigation. It allows them to make a monetary gift during their lifetime for Inheritance Tax purposes; part of that gift could be treated as a discount and falls outside their estate immediately for Inheritance Tax. The other part of the gift is treated as a transfer of value for Inheritance Tax, and the Inheritance Tax treatment will depend on the type of trust used.

If a client has a lump sum to invest but is unable or unwilling to give up complete access to their capital, a Discounted Gift Trust, in conjunction with the HSBC Life Onshore Investment Bond, will (subject to certain conditions) enable them to achieve an immediate reduction in their estate for Inheritance Tax purposes. In addition, retaining access to a regular stream of capital payments can improve cashflow during their lifetime.

Generally, an investor for whom this trust arrangement would be appropriate will:

• have a net estate exceeding £325,000;
• have capital to invest;
• require access to this capital, but will be happy to restrict this access to a series of fixed regular payments; and
• be aged between 18 and 89 years old.

To obtain a discount on the value of the amount transferred into trust, your client needs to be in reasonably good health. However, having said that, less than perfect health should not be a bar to creating a trust of this kind, provided the implications for Inheritance Tax and estate planning are understood and accepted.

What are the benefits of a Discounted Gift Trust?

By putting the HSBC Life Onshore Investment Bond into a Discounted Gift Trust, your client can:

• potentially achieve an immediate reduction in the value of their estate for Inheritance Tax purposes;
• further reduce any potential liability to Inheritance Tax if they survive for seven years from making the gift
• receive fixed regular payments during their lifetime; and
• select trustees who will administer the trust and distribute any remaining trust fund to the beneficiaries after their death.

Apart from the fixed regular payments, your client will have no access to their investment once they have created the trust. Find out more if this is the right option for your client by referring to the HSBC Life Trust Decision Tree.

What the HSBC Life Onshore Investment Bond offers?

• Direct investment into funds – The Bond invests directly into collective investments such as open-ended investment companies (OEICs) and unit trusts rather than mirror funds.
• Flexibility – The Bond can be split into a maximum of 1,200 segments to allow tax planning flexibility.
• Transparent charging structure – All transactions are undertaken through a cash account showing charges for investment, administration and advice.
• Value for money – By linking to the actual funds offered by fund managers (rather than replicating those funds ourselves), we can offer a competitively priced proposition with minimal administration costs.
• Multi-life financial planning – the ability to have up to 10 lives assured gives flexibility that will be particularly attractive to trustees.

How does a Discounted Gift Trust work?

A Discounted Gift Trust can be set up as an absolute or discretionary trust. Considerations include:

• how much flexibility clients need in changing the beneficiaries;
• how much control trustees should have and how beneficiaries may benefit; and
• how the settlors and trust will be treated for Inheritance Tax purposes.

What are the main considerations around the discount and gift?

HSBC Life calculates the discount when the trust is established. So, for example, if your client dies within seven years of the establishment date, HMRC will typically accept the discount, if available, without further enquiry.

The settlor’s retained rights are the right to a series of regular fixed payments and is also referred to as the discount. This discount is deducted from the amount transferred into trust.

The fixed regular payments continue during the settlor’s lifetime or until the bond is exhausted, whichever occurs first. The value of the settlor’s retained rights are zero on death.

We calculate the discount according to various factors, including age, state of health, the level and frequency of payments you choose to take and the rate of growth which meets HMRC guidelines.

The remainder of the amount invested is the value of the gift for Inheritance Tax purposes. Depending on the type of trust used, this gift will be either a potentially exempt transfer if an absolute trust, or a chargeable transfer if a discretionary trust.

What are the different types of Discounted Gift Trusts?

An absolute trust can be used if your client knows exactly who should benefit from the trust fund after their death. When creating the trust, they must specify the beneficiary(ies) and, if more than one, the share of the trust fund to which they are each entitled. They cannot change their mind at a later date.

An advantage of inheritance tax is that the absolute discounted gift will be treated as a potentially exempt transfer for Inheritance Tax purposes. This means that there will be no immediate Inheritance Tax charge and, provided that your client survives for at least seven years after making the gift, the whole of their trust fund will be free from Inheritance Tax on their death.

A discretionary trust may be chosen if your client wants to retain some flexibility over who will benefit. No beneficiary will have a fixed right to anything; instead, it will be up to the trustees to decide who will benefit, in what proportion and when the trust fund will be distributed after the settlor’s death. The trust deed sets out the classes of beneficiaries who can benefit, and your client can add named individuals to the trust deed.

As a result of the flexibility provided by a discretionary Discounted Gift Trust, the discounted gift will be classed as a chargeable transfer with the following Inheritance Tax implications:

• there will be an immediate tax charge of 20% paid by the settlor on any amount of the gift which, when added to any other chargeable transfers your client has made in the past seven years, exceeds the nil rate band;
• there could be a further charge if your client dies within seven years of setting up the trust;
• Inheritance Tax will potentially be payable on every tenth anniversary of the trust and when any distributions are made.

How does the application process work?

1. Complete the statement of health form

2. The discount will be assessed and confirmed

3. Once the discount has been provided, please complete the trust and bond application forms

The value of the gift they are making will fall outside their estate, provided they survive for seven years from creating the trust.

How will payments be received?

Your client can choose between monthly, bi-monthly (every other month), quarterly, termly (every four months), half-yearly or yearly options for their regular payments.

Once selected, regular payments are fixed and will continue throughout your client’s lifetime unless, of course, the value of the Bond falls to nil, when payments will cease.

Clients can choose any level of payment up to 10% per year of the amount they invest. However, remember that the value of the Bond will reduce if the amount withdrawn exceeds the rate at which the Bond grows.

How should the trust fund be invested?

Who should be a trustee?

What are absolute and discretionary beneficiaries?

Under an absolute trust, your client will name those they wish to benefit and the shares they should take. Once they have made this choice, they cannot change their mind. In the event of your client’s death, the trustees will be able to pay the appropriate share of the trust fund to any adult beneficiaries. The trustees will usually have to retain the trust fund where there are minor beneficiaries until each beneficiary reaches age 18 (16 in Scotland).

Under a discretionary trust, the beneficiaries are described as a class of individuals such as your client’s children, grandchildren, nieces, nephews, spouse or surviving spouse (unless they created the trust as joint settlors or deliberately excluded their spouse) and the spouse or surviving spouse of any of the beneficiaries.

What happens to a Discounted Gift Trust on death?

If someone associated with the trust dies, the trustees should notify us as soon as possible. We need to know if:

• the settlor dies;
• a trustee dies; or
• a life insured dies.

The steps required depend on the role of the person who died.

What happens if the settlor dies?

If a single (or surviving) settlor of an absolute trust or discretionary trust dies, the trustees must advise us to stop making the regular withdrawals. The trustees will then be able to distribute the trust fund to the beneficiary(ies).

What happens if a trustee dies?

If a trustee dies, the remaining trustees must advise us of this and provide evidence in the form of a copy of the Death Certificate.

What happens if a life insured dies?

If one of the lives insured dies but is survived by other lives insured, there will be no effect on the arrangement, and the Bond will continue.

What happens if a beneficiary dies?

If a beneficiary of an absolute trust dies, the value of the trust fund, less the value of the Settlor’s Retained Right, will be included in the beneficiary’s estate for Inheritance Tax purposes.

Do Discounted Gift Trusts need to be registered with the TRS?

Yes, any Discounted Gift Trust needs to comply and use the Trust Registration Service. In addition, affected trusts must appoint a lead trustee or agent to register as HMRC’s primary contact. See the Trust Registration Service page for more details.

What are the income tax liabilities?

Your client can arrange to receive regular payments of up to 5% of the original investment every year without any immediate income tax charge. In addition, any unused part of this allowance can be carried forward, so they can potentially defer any higher or additional rate income tax liability until 100% of the original investment has been withdrawn, or the Bond ends.

Any amount over the available 5% allowance is usually added to their income and may be subject to income tax. If this increases your client’s income above £100,000, their personal allowance may be reduced.

The taxation of discretionary trusts

The rate for taxation of trusts will depend upon whom the liability falls.

– The settlor will be charged at their highest marginal rate

– If the settlor cannot be taxed (because they are either deceased or a non-UK resident), then the UK resident trustees will be taxed at 45%, but will also receive a credit for basic rate tax of 20%

– Where a beneficiary is liable, the tax paid will depend on their personal income tax position