Discounted Gift Trust Advantages and Disadvantages Explained

A discounted gift trust is a popular estate planning tool offering tax efficiency and asset protection. Among the discounted gift trust advantages and disadvantages, benefits include reducing inheritance tax liabilities and providing regular income for the settlor. However, disadvantages can involve limited access to capital and potential complexities with taxation. Understanding the discounted gift trust advantages and disadvantages is crucial for making an informed decision in estate planning.

Discounted Gift Trust: Advantages and Disadvantages

Advantages of a Discounted Gift Trust

The advantages of a discounted gift trust include significant estate planning benefits, such as reducing inheritance tax liabilities while providing a lifelong income for the settlor. As a matter of fact, this kind of trust will enable the settlor to actually transfer wealth out of his or her estate, retaining access to regular payments. Finally, this kind of trust would protect the assets from creditors and all other litigations. It was a means of safely managing and preserving any future wealth. Everyone will be better prepared to make suitable financial decisions if they understand what the advantages of a discounted gift trust are.

1. Reduction of Inheritance Tax (IHT): Principally, one of the primary advantages of a discounted gift trust is the inheritance tax liability. Making a gift of the investments of the individuals into the trust automatically reduces the valuation of the estate, which is very advantageous to an individual worried about the repercussions of this tax to the beneficiaries. The portion of the gift that is considered a "discount" (typically the right to a fixed income during someone's lifetime) does not count at all in the valuing of the estate, effectively reducing potential IHT liabilities.
2. Lifetime Income: The settlor has the right to receive an income from the trust, usually throughout their life, on a regular basis. This ensures that a constant flow of income is available to persons who may have settled only their assets in a trust but who really need to make a major gift and yet have no means other than the income to meet their daily living expenses.
3. Estate Planning Flexibility: There is a discount gift trust, which allows a lot of flexibility while planning one's estate. This does not only serve the purpose of reducing the value of one's estate, it also gives a systematized way for the transmission of wealth regarding settlement according to the wishes of the settlor.
4. Control Over Trust Assets: The trust structure provides an opportunity for the settlor, the one establishing the trust to have some level of control over how the resources from the trust would be relinquished after their demise. The managing of these assets lies with the trustees, who ensure the future disbursement complies with the trust deed.
5. Avoidance of Probate: Assets that are in a discounted gift trust are not included in the estate of a settlor, while details will avoid probate. This will save lengthy and sometimes costly probate and will allow faster access by the beneficiaries to the assets.

Advantages of a Discounted Gift Trust

Disadvantages of a Discounted Gift Trust

While offering many benefits, there are some disadvantages of a discounted gift trust to consider. Once established, the trust is irrevocable. That fact, in turn, means that, beyond the agreed-upon level of income, the assets cannot be accessed. Besides this fact, setting up a discounted gift trust might have implications regarding eligibility for means-tested benefits and may be burdened with a number of complex legal and tax considerations. The associated costs of establishment and ongoing management of the discounted gift trust can also be high. Understanding the disadvantages of a discounted gift trust is essential before committing to this estate planning tool.

1. The major downside of most discounted gift trusts is that they are irrevocable. The instant the assets get transferred into the trust, they cannot be undone. This can be a downside if the settlor's financial picture changes, as they cannot reclaim the capital.
2. Capital Concern: The settlor cannot get hold of the trust's capital, only the income. This will really be an issue whenever he requires so much money that he did not foresee.
3. Effect on Means-Tested Benefits: Since assets are transferred into a discounted gift trust, there is the likelihood of this being considered as means-tested benefits, even though the settlor will continue to receive the set amount.
4. Complexity and Costs: Setting up and maintaining a discounted gift trust can be complex, requiring legal and financial advice. There are initial setup costs, and ongoing management fees paid to trustees and financial advisors can add up over time.
5. Inheritance Tax Implications on Death: It would also normally apply a presumption that, within the first seven years, the gift would have remained part of the estate of the settlor and have IHT implications. That could well result in a tax consequence which may be less than it would have been in the event of a discount on the gift.

Disadvantages of a Discounted Gift Trust

Discounted Gift Trust Taxation

Discounted gift trusts benefit from the following tax treatment for estate planning purposes:

1. Inheritance Tax (IHT) Discount: Even though the gift into trust is putatively an exempt transfer for IHT, a discount is made because the settlor retains the right to a regular income from the trust. This represents the estimated value of the retained income stream and, for effect, reduces the gift's value for IHT calculations.
2. The Seven-Year Rule: An IHT can only be fully exempt when its settlor stays alive for seven years after incorporation. If a settlor dies within seven years of incorporation, then IHT may be chargeable at the value of his gift, less the discount.
3. Trust Income Tax: Since the settlor receives living payments from the trust fund, which is his income, income tax will have to be paid on this income. The tax treatment depends on the tax rate of the settlor and on the income type: interests, dividends, etc., which the assets held generate.
4. Tax Treatment for Beneficiaries: Any value left within the trust on the settlor's death generally is free to be passed to the beneficiaries without further IHT being triggered unless the settlor dies within the seven-year period.

Discounted Gift Trust Worked Example

An individual aged 70 invests £500,000 into a discounted gift trust.

• Step 1: Discount Calculation:

An individual settles the trust with a principal of £500,000 and the right to an annual income of £25,000. Actuarial calculations suggest a discount that, based on the age of the settlor, life expectancy, and the probability of the existence of an income stream, may be valued in the order of £200,000.

• Step 2: Gift to the Trust

The gift, excluding the discount, is valued at £300,000, and hence it might be subject to IHT should the settler survive for a minimum of seven years.

• Step 3: Income Stream

The settlor retains an income from the trust property amounting to £25,000 each year. Such an amount is taxable income to the settlor and will be received for his life.

• Step 4: On Death

If the settlor dies after seven strokes of years, the £300,000 becomes outside the estate for IHT. But should the settler die within seven years, then the £300,000 becomes part of the estate but applies for the discount available and tapers if applicable.

Discounted Gift Trust Worked Example

Conclusion

While the concept of a discounted gift trust may help in estate planning and result in the reduction of IHT liability to a minimum, it also comes with the twin benefit of providing a lifelong income. Among the discounted gift trust advantages and disadvantages, the key advantages include tax efficiency and the ability to maintain an income stream. However, its irrevocable nature, potential effects on means-tested benefits, and associated costs highlight the importance of understanding both the discounted gift trust advantages and disadvantages.

At One Pacific Trust, we recommend seeking advice from financial and legal experts before setting one up. This knowledge will help individuals make more informed decisions, guided by their own financial goals and legacy planning needs, while also considering the tax advantages. One Pacific Trust offers tailored solutions to navigate the complexities of discounted gift trust advantages and disadvantages effectively.