Discounted Gift Trust

Mrs S is a 71 year old widow with four children. Her estate is valued at £575,000 and includes funds on deposit. Although Mrs S is aware that she has an IHT problem, she feels unable to make lifetime gifts, as she requires the income from her investments to maintain her standard of living.

She is also worried about funding care costs should this prove necessary.
If no action is taken, her estate, above the available nil rate band, will be subject to inheritance tax at 40% on death. Under current rates this would mean that each of her children will inherit a smaller sum than the tax payable to HMRC.

Solution

Mrs S invests £250,000 into a Discounted Gift Scheme and reserves the right to an income of £1,000 each month. As her health is normal for her age, Mrs S’s gift will be discounted by £109,757 to reflect the anticipated value of the rights retained (this discount is calculated based on her age and income being taken, please remember this an example only and would need to be agreed by HMRC). This means that her chargeable lifetime transfer will be reduced to £140,243 for IHT purposes. As Mrs S has made no other chargeable lifetime transfers in the last seven years, there will be no immediate charge to tax.

In the event of Mrs S’s death five years later, her estate is theoretically valued at £465,243 (that is, £325,000 remaining estate plus the discounted gift of £140,243). After allowing for the nil rate band, use of the Discounted Gift Scheme has resulted in a tax saving of just over £43,000 at current rates. Had Mrs S survived for seven years, the entire trust fund could have been appointed to her children, free of inheritance tax – a tax saving of £100,000 while still securing a reasonable level of income.

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