‘Off-the-shelf’ trusts offered by UK life insurance companies (and their overseas branches) offer financial planners a trust solution that may help reduce or exempt clients from inheriting tax (IHT) burdens.
The Big 4 are gift trusts, loan trusts, discount gift trusts (DGT) and flexible reversionary trusts (FRT).
Aside from the same day accrual rule introduced by IHTA84/S62A Finance Act 2015 (No.2), the last time the Government made any significant changes affecting the above four types of trusts was in March 2006. It was the 22nd. Although the introduction of the Trust Registration Service (TRS) is important, the TRS does not affect planning considerations for these trusts.
Other than the continued freezing of the zero-rate band, there have been minor changes recently. For example, a reduction in the annual capital gains tax exemption will affect non-bear trusts. However, it is generally not relevant when these trusts hold investment bonds.
The Spring 2023 Budget announced simplifying changes to low-income trusts that will come into effect from 6 April 2024.
This means, broadly speaking, that a trust with any kind of income up to £500 will not pay or report any tax when that income is generated. If your income exceeds that amount, you will be taxed on the full amount. This also means the removal of the £1,000 standard interest rate band for discretionary trusts.
However, there was a more recent change affecting one of those trusts. On April 17, HMRC increased the interest rate applicable to the valuation of reserved rights under the DGT scheme from 4.5% to 6.75%, with the change effective May 1, 2023.
What does this mean?
In a nutshell, the discount rate has been reduced as shown below.
Single immigrant turns 68 on next birthday
Standard Interest Underwriting Decision
Gift of £400,000 (Settlor reserves £1,500 monthly payment)
Interest rates before May 1, 2023:
Discount = 57.76% (£231,050*)
Estimated Gift = £168,950
Interest rates applicable after May 1, 2023:
Discount = 47.34% (£189,350*)
Estimated Gift = £210,650
* HMRC requires the open market value of any rights held by settlers to be rounded to the nearest £50. Discounts may vary depending on his DGT provider, but usually the difference is negligible.
Does this change affect the conformance of DGT recommendations?
In short, the answer is no. DGT provides a solution for clients who wish to gift capital for the purpose of alleviating their IHT liability, but who need lifetime access to pre-determined capital payments (reserved rights) to maintain their spending needs To do.
These objectives are achieved regardless of whether discounts are available. Non-exempt customer gifts, i.e., “discounts” that immediately reduce the value of a potentially exempt transfer (PET) or fee-charging lifetime transfer (CLT), are a by-product of rights held and not for planning purposes of the trust.
Focusing solely on discounts can result in negative client income. For example, as the level of reserved rights increases, so does the discount. However, if the rights held exceed what the customer needs and spends, excess capital is likely to accumulate in the property, counterproductive to IHT mitigation goals.
Since these changes were announced and implemented within 10 business days, many financial planners will already be doing their analysis using benchmark discounts based on old interest rates.
Many planners have applied during the underwriting stage, and some may have already underwritten but have not yet made a decision to proceed. All cases in this position are subject to the new interest rate, resulting in a lower discount rate.
From a planning perspective, the financial planner may need to review the gift amount if the strategy targets a specific transfer amount.
A common example is to target maximum CLT without creating an entry charge.
Therefore, it is imperative to obtain a revised index discount from your DGT provider to understand the impact on your planning strategy. If changes are required which means that the trust deed no longer reflects the settlor’s intentions, a new trust deed will be required as the trust deed cannot simply be amended after execution.
The key point from a planning perspective is that DGT is a better solution than gift trusts, loan trusts, or FRTs to meet the customer’s IHT, even with lower discount rates (or no discounts at all). The basic reason for doing so remains the same. Access to capital targets.
Fundamentally, DGT suitability requires a discount factor.
Barrie Dawson is a technical manager at M&G Wealth