The announcement in the 2013 Budget that the inheritance tax (IHT) threshold would be frozen at £325,000 until at least April 2018, means the use of traditional estate planning tools such as trusts is likely to become more popular.
In the current financial climate many might not be able to sacrifice any income and gift money away completely with the hope of living a further seven years that make it a potentially exempt transfer (PET).
Therefore tools such as the discounted gift trust (DGT) or a gift and loan trust which allow the settler to receive some kind of income or access to the capital may become more utilised.
David Downie, technical manager at Standard Life, notes: “Since HMRC extended its anti-avoidance reach with the introduction of the General Anti Abuse Rule (GAAR) and inclusion of IHT within the Disclosure of Tax Avoidance Schemes (DOTAS) rules, it is unlikely we will see many new IHT planning solutions. Most estate planning will be centred on tried and tested solutions such as discounted gift trusts or loan trusts.
“Discounted gift trusts allow you to make an IHT effective gift yet still retain the ability to continue receive payments from it for the rest of your life. And the icing on the cake is that the amount you are treated as giving away for IHT is reduced by the payments you might expect to receive.”
He adds: “Loan trusts are excellent for those people who are still a little uncomfortable about giving away their assets. It allows access to their capital should their circumstances change but still ensures that the growth on the investment is free from IHT. And each time they take a loan repayment the value of their estate is being reduced.”
Of course there is still some potential liability to IHT in using these schemes, with the initial transfer into a DGT potentially liable to a chargeable lifetime transfer (CLT) of 20 per cent, although providing they survive for seven years no further IHT would be liable.
Marilyn McKeever, associate director in the private client practice at Berwin Leighton Paisner, explains: “An individual who makes a gift to a trust in their lifetime will potentially be subject to 20 per cent inheritance tax upfront. However, discounted gift trusts typically involve giving some rights under an insurance policy to a trust, while retaining other rights.
“The key benefit of this kind of arrangement is that because the donor retains a part of the value, the value of the gift is reduced, which in turn reduces – or eliminates – the potential inheritance tax liability.”
In contrast she points out gift and loan trusts involve the individual making a loan to a trust, so the value of the loan is an asset owned by the lender and remains subject to inheritance tax.
She adds: “The growth in value of the investments made by the trustees with the borrowed money is outside the individual’s estate for IHT purposes. The loan avoids the 20 per cent ‘entry charge’ but the growth in value will still be subject to periodic IHT charges within the trust and if the trust assets are transferred to beneficiaries.”
