WRIT

14 Journal of the LSNI
Spring 2016
Beware of the
limitations of
Discounted Gift
Trusts in Estate
Planning
Estate planning invariably attempts
to achieve a blend of the following
objectives – mitigating a Potential
Inheritance Tax (‘IHT’) liability, allowing
beneficiaries access to assets at an
appropriate time and (the illusive)
ability for the settlor to retain some
access to the assets or receive an
income.
The most simple and cost effective solution
of an outright gift is often dismissed as many
people are not in a position to gift capital, as
they cannot be sure they will not need it to
provide for their own future financial security.
Therefore the ideal solution for many clients is
one where they can achieve the potential IHT
savings that an outright gift offers yet retaining
access to capital or an income.
The Gift with Reservation of Benefit (‘GWR’)
rules introduced in 1986 and Pre-Owned Assets
(‘POA’) rules of 2004/05 target some of the
more aggressive structures aimed at achieving
the “have your cake and eat it” objective.
Discounted Gift Trusts (‘DGT’) are often portrayed
as the structure which best achieves this goal.
The key attractions of a DGT are twofold. Firstly,
the ability to place an amount greater than the
available nil rate band into a discretionary trust
without incurring a Chargeable Lifetime Transfer
(‘CLT’) and secondly the ability to retain an
ongoing “income” from the trust.
While a DGT undoubtedly has some very
attractive features (the discount is outside
the estate immediately and the remainder
after seven years), the discount is merely the
capitalised value of the retained income rights
and these “income” payments will simply
accrue back into the settlor’s estate unless
spent. Therefore the DGT is unlikely to be
suitable for those clients that do not require an
immediate and ongoing income.
“Careful consideration should be made
prior to establishing a Discounted Gift
Trust and in many cases the lesser
known Flexible Reversionary Trust may
be a more appropriate solution.”
A further disadvantage of the DGT is that while
the settlor retains an “income” they lose the
access to capital. In addition the income level
and timing of payments is likely to be set at
outset and cannot be changed. While this may
not seem like an issue at the outset it can create
problems in the future. An income set at 5% of
the initial DGT value will fall by 22.4% in real
terms with an inflation rate of 2.5% per annum
over 10 years. While inflation is low at the
moment, many predict it will rise in the future
as Governments pay the price of Quantitative
Easing (‘QE’).
“For it is in giving that we receive” - St
Francis of Assisi
For many clients, as they grow older and have
more certainty that their own needs will be
met, they can now afford to give away assets
and benefit from seeing the joy their gift gives
to the beneficiaries. The perceived value of the
gift by the beneficiary is also likely to be greater
the sooner in life that they receive it. A 40 year
old with a mortgage and three children is likely
to appreciate a gift more so than a 60 year old
with no mortgage and financially independent
children. Many DGTs do not allow payments to
beneficiaries until the settlor has died.
Having looked at the disadvantages of the DGT,
what alternatives are there? An often overlooked
gem is the little known Flexible Reversionary
Trust (‘FRT’). Similar to a DGT the right to an
“income” is carved out at the outset, however
the power of the trustees to vary the “income”,
creates additional, valuable flexibility. The
main advantages of an FRT over a DGT are that
income benefits need not be taken at all. They
can be deferred to a later date and can vary
in the amount taken. But a ‘discount’ will not
be available. After seven years, if the annual
“income” payments have been deferred the
settlor would have the whole value of the trust
fund outside of their estate while retaining
access to the full trust value. In addition,
payments can be made to beneficiaries at any
time without further IHT implications.
FRTs therefore often appeal to clients who want
to set up a discretionary trust but want to retain
access to the capital, knowing that they are