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Waiving the Settlor's entitlement on a DGT

Date: 11 December 2024

4 minute read

Who is this article for?

Advisers wanting to understand the advantages and disadvantages of their client waiving the right to withdrawals within a discounted gift trust.

Key takeaways

Discounted gift trusts provide withdrawals for life in return for a ‘discount’ from a lifetime gift but what happens if the withdrawals are no longer needed?

1. Discounted gift trust

Under a discounted gift trust (DGT) the settlor makes a lifetime gift to trustees (usually in the form of an investment bond) but they carve out the right to receive withdrawals for life or until the trust fund is exhausted (usually up to 5% to benefit from the bond’s tax-deferred allowance). The withdrawals are based on life expectancy of the settlor and actuarial calculations, which provide a market value, i.e. what someone might expect to pay for the right to receive withdrawals. This figure is then used to establish a reduced value of the gift for IHT purposes.

The result of the discount is that an instant IHT saving can be achieved (as the discount is immediately outside the estate) and it allows for a more substantial investment to be made using a discretionary trust, above the level of the nil rate band (NRB).

It is important to note that the discount quoted by an insurer is not guaranteed and HMRC can challenge the underwriting opinion and therefore figures quoted. However, a prudent approach by the insurer, i.e. underwriting in advance for all cases and use of the HMRC-prescribed interest rate in the discount calculations, should help to minimise the likelihood of any challenge.

 

2. What options are available if withdrawals are no longer required?

The question of ‘how do I stop my withdrawals?’ and ‘what are the implications?’ arises more often than you would think. If the deed allows for withdrawals to be waived, it can be stopped or reduced. However, the loss to the estate must be valued and therefore a new gift for IHT purposes has been made.

Withdrawals are often waived in three ways:

  1. Waive for a short period of time, i.e. settlor waives for six months.
  2. Waive indefinitely, i.e. settlor never wants any withdrawals again.
  3. Waive until further notice.

So what is the open market value of the asset in the transferor's hands before the action of waiving? In the first scenario this seems quite simplistic as six times the monthly withdrawal amount would give an idea of the value lost, with inflation/future value of money not really a factor.

With the second option the loss will simply be the open market value of the right to receive withdrawals at the date of transfer, similar to estimating the initial discount but using the revised parameters. Most insurers will not undertake this process due to the costs involved with re-underwriting the individual for a second time. It is therefore down to the settlor to seek appropriate advice and record the value of the gift as it will need to be disclosed should they die within seven years of giving up their right to withdrawals.

The third option ‘until further notice’ for IHT valuation purposes is treated as if there is ‘no market value’ – and therefore no transfer of value is deemed to have occurred.

The reason for this -  is what value would an open market purchaser place on the ‘right to receive withdrawals’ in these circumstances? As it is unlikely that anyone would buy such a right, as it is unclear when it will restart, there is no market value retained.

There could be no question of any retrospective valuation as s160 IHTA 1984 confirms the ‘market value’ used for valuing assets is the value at that time.

 

3. Conclusion

Funds that are within the settlor’s estate are potentially liable to 40% IHT on death whereas the future right to withdrawals, prior to any decision to waive, is immediately outside the estate on death. Assuming the trust deed allows for the withdrawals established by a DGT to be waived, it might be worth seeing if these withdrawals can be used in other ways before recommending such action. This will avoid a new gift and seven-year clock.  

If the ‘withdrawals’ from the DGT are not required and are just being accumulated within the estate, other options might be available. The withdrawals are classed as capital from an investment bond, so the settlor will not be able to use the ‘gifts out of income’ exemption. Other exemptions might be available, including annual exemption, small gifts and charitable donations. 

 

For financial advisers only. Not to be relied on by consumers.

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