Succession Planning Bond - Aviva · PDF file4 inheritance tax Inheritance tax has its origins...
Transcript of Succession Planning Bond - Aviva · PDF file4 inheritance tax Inheritance tax has its origins...
Succession Planning Bond Trust Guide
2
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Inheritance Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Domicile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Reducing the effect of IHT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Transferring assets/Gifting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Insuring the liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
IHT planning using trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Trust planning decision tree . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
The Discretionary Gift Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
The Discretionary Loan Trust . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
The Discretionary Capital Access Trust . . . . . . . . . . . . . . . . . . . . . . 20
The Discretionary Discounted Gift Trust . . . . . . . . . . . . . . . . . . . . 22
Wills & Intestacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Glossary of Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
contents
3
introduction
The aim of this guide is to give a brief outline of UK inheritance tax (IHT), and to highlight some of the opportunities available for inheritance tax planning using Friends Provident International’s Succession Planning Bond. The information applies to individuals who are UK-domiciled for IHT purposes, and to individuals who are non-UK domiciled, but UK resident.
This guide and the information contained within it should only be used in consultation with
a Financial Adviser.
All Discretionary Trusts will be treated as a “relevant property” settlement. The following
is our understanding of the tax consequences of creating a relevant property settlement:
• The initial gift is a chargeable lifetime transfer (CLT) subject to inheritance tax at
20% to the extent that it, together with other CLTs made by the same Settlor in
the seven years before creating the Trust, exceeds the current nil rate band. The
gift will be the value of the policy that is gifted into trust less the value of the
Settlor’s entitlement under the trust.
• There is a potential liability on the trust to inheritance tax on every 10th
anniversary. This is known as the “periodic charge”. At a maximum this will be
6% of the value of the trust fund but will frequently be much less than this.
• There is a potential liability to inheritance tax when capital leaves the trust (an
“exit charge”) which will be linked to the rate of IHT paid at the last ten year
anniversary or, if the capital leaves the trust in the first 10 years, when the trust
was created. Payments made to the Settlor in respect of his entitlement under
the trust will not be subject to the exit charge.
HMRC Reporting
It is currently a legal requirement for any chargeable lifetime transfers that comprise of
cash and cause the Settlor to exceed his/her nil rate band to be reported to HM Revenue
& Customs (HMRC) on Revenue forms IHT 100, IHT100a and D34. These forms are
available on the HMRC website at www.hmrc.gov.uk/cto/forms12.htm
The occasion of a periodic charge or exit charge also needs to be reported even if no
IHT liability arises unless the cumulative total of the assumed transferor does not exceed
80% of the then nil rate band. The forms to use here, when relevant, are IHT 100c and d,
and form D34.
This information is correct as of December 2012.
4
inheritance tax
Inheritance tax has its origins as far back as the Roman Empire. Caesar Augustus introduced an inheritance tax to provide retirement funds for the military.The tax was 5% on all inheritances except gifts to children and spouses.
Inheritance tax (IHT) in the UK is both a cumulative tax on death, and on certain transfers
(gifts) made during a person’s lifetime.The first £325,000 (2012/13)* the ‘nil rate band’
(NRB) is free of IHT.
Every individual has a NRB, which until recently could be lost on death if transfers were
made between spouses or civil partners (CP). Following the Chancellor’s pre-Budget
statement on 9th October 2007, any part of the NRB which is not used on the death of
the first spouse (CP) can now be carried forward and used by the surviving spouse (CP)
on their death.
Chargeable lifetime transfers over the NRB are taxed at 20% and on the total value of
an individual’s estate on death at 40%. The total estate on death is the value of the
UK-domiciled individual’s combined assets, wherever in the world these assets are
situated, and include real property, investments and personal effects.
* The current NRB was set in 2009/10 and has been frozen for five years to 2014/15
Example 1
The example shows how the value of
a person’s estate can be significantly
reduced by inheritance tax.
5
example
Mrs White is a widow with three children. Her husband left his estate completely to her
on his death. When Mrs White dies, her estate on death includes:
£
House 900,000
Investment property 300,000
Investments 333,333
Deposits 100,000
Personal effects 100,000
Total Estate 1,733,333
Less nil rate bands 2 x 325,000 (650,000) †
Estate for IHT 1,083,333
Tax 1,083,333 x 40% = 433,333
Estate 1,733,333 – 433,333 = 1,300,000
Beneficiary£433,333
Beneficiary£433,333
Beneficiary£433,333
HMRC£433,333
Estate£1,733,333
† Mrs White’s current NRB plus Mr White’s unused NRB
the effect of
inheritance tax
6
domicile
An individual’s liability to UK inheritance tax is primarily governed by their domicile at the time a transfer of value takes place. A person domiciled in the UK is liable to inheritance tax on the total value of his or her assets wherever in the world these are situated.
The basic concept of domicile is that a person is domiciled in the country that he or
she regards as their real home. Domicile is normally acquired through birth, through
parents or through long-term residence.
The UK concept of domicile goes beyond a mere physical presence in the UK, which
means UK-domiciled individuals could find that their worldwide assets are subject to
UK inheritance tax even though they are not physically resident in the UK at the time.
The main categories of domicile:
• Domicile of origin
• Domicile of dependency
• Domicile of choice
• Deemed domicile
7
Domicile of origin
Under English law, an individual acquires at birth the domicile of the person on
whom he or she is legally dependent, which the individual retains until reaching
the age of 16.
Domicile of dependency
If the domicile of the person on whom an individual under the age of 16 is legally
dependent changes, he or she will acquire the new domicile automatically, which
will be retained until the age of 16.
Domicile of choice
On reaching the age of 16, a person has the legal capacity to acquire a new
domicile of choice. To acquire a new domicile of choice, the individual must leave
the country of his or her current domicile and settle permanently in the new
domicile of choice. A change of domicile to a new domicile of choice requires
strong evidence (in addition to just living there) that the change of domicile is
permanent.
Deemed domicile
For inheritance tax purposes, there is a concept of ‘deemed domicile’. This means
that, even if the individual was not at the time domiciled in the UK, he or she will
be treated as domiciled in the UK if, at the time a transfer of value was made:
• he or she was domiciled in the UK within three years immediately prior to the
transfer, or
• he or she was resident in the UK in at least 17 of the 20 income tax years
ending with the year in which the transfer was made.
8
reducing the effect of iht
According to HMRC, the number of families caught by IHT has more than doubled over the last 10 years. Despite this, only a small percentage of the population actually paid this tax. This is because there are a number of simple and effective ways of reducing the tax. As well as using available reliefs, careful planning can in most cases avoid the tax completely and preserve the value of the estate for the chosen beneficiaries.
Transferring assets/Gifting
Transfer of value
A transfer of value is a disposition made by a transferor, whereby the value of the estate
immediately after the disposition is less than it would have been had the disposition not
been made. This is often referred to as the ‘loss to donor’ principle, and is one of the basic
principles of IHT.
Chargeable transfers
A chargeable transfer is a transfer of value made by an individual, which is not an
exempt transfer.
Exempt Transfers
There are a number of transfers (gifts) that are normally exempt from IHT:
• Transfers between Spouses (Civil Partners) – are exempt from IHT if both
spouses (CP) are UK-domiciled. Where a transfer of value is from a UK-domiciled
spouse to a non-UK domiciled spouse, then the exempt transfer is limited to
£55,000.
• Annual Exemptions – each individual can transfer an exempt amount of up to
£3,000 per year. Any unused amount can be carried forward for one year only.
• Small gift exemption – up to £250 per person in each tax year.
• Normal expenditure out of income exemption – unlimited amounts can be
transferred free of IHT provided the following conditions are met:
– The transfers are regular in nature and come from the donor’s income
– The donor’s standard of living is not reduced as a result of the transfers.
• Gifts on marriage (CP) – gifts in consideration of marriage (CP) are exempt
transfers up to a maximum of £5,000 if given by each parent, £2,500 by each
grandparent, £2,500 by the bride and groom (CP) to each other, or £1,000 by
anyone else.
• Gifts to charities and political parties – are exempt transfers with no limit.
• Gifts for the national benefit – are exempt transfers with no limit.
This information is correct as of December 2012.
9
Potentially Exempt Transfers (PET)
These are transfers of value made between one individual and another individual, to a
bare trust or to a trust for a disabled person. To be totally effective for IHT purposes the
transferor must survive a period of seven years from the date of the transfer.
If the death of the transferor occurs within seven years of the PET, the amount of the
transfer will be deducted from the individual’s NRB.
Where the transfer exceeds the NRB, then the excess will be added back into the estate
as a chargeable transfer.
Taper relief may reduce the amount of tax payable depending on when within the seven
years the transferor dies – see the table below.
Years before death in which transfer was made
1 – 3
3 – 4
4 – 5
5 – 6
6 – 7
Percentage of tax payable on transfer
100%
80%
60%
40%
20%
Effective rate of tax
40%
32%
24%
16%
8%
10
reducing the effect of iht (continued)
Gifts with reservation
Property that has been transferred (gifted) may still form part of the transferor’s estate for
IHT purposes, if the transferor reserves the right to enjoy or benefit from the gifted property
(see Example 2 opposite).
Insuring the liability
Whole of life assurance
Covering the IHT liability with a life assurance policy is an affective alternative to transferring
(gifting) assets, providing, of course, that the policyholders are in good health and still young
enough to make the premiums affordable.
The policy is normally written as a whole of life last survivor
policy, and held in trust for the beneficiaries. The proceeds
are paid on the death of the last of the lives assured to die,
and then used by the beneficiaries to pay the inheritance
tax. One or more of the exemptions could avoid the
premiums being charged as lifetime transfers.
Term assurance
It is a common tax planning exercise when effecting a PET for the transferor to effect a
seven-year decreasing term assurance policy at the same time. The policy sum assured
covers the outstanding IHT liability should the transferor die within the seven-year period.
The sum assured decreases in line with the taper relief, and has no value after seven years.
Example 2
Gifts with reservation
11
reducing the effect of
inheritance tax
example
Example 2
Tom Adams has a large estate made up of his main residence and a collection of
paintings. He is aware that his estate will attract a large IHT bill when he dies.
He decides to reduce the value of his estate by giving his son one of his valuable
paintings. This he does, and on doing so, asks his son as a favour, to leave the painting
on his study wall.
This is a gift with reservation as Tom can still enjoy the painting even though he has
given the painting to his son. On this basis the painting will remain part of Tom’s estate
for IHT purposes.
12
Transferring an asset (such as an offshore investment bond) into trust will change the legal ownership of that asset. This invariably changes the taxation of the asset, which creates a number of important tax-planning opportunities for the adviser to consider.
One of the most effective uses of trusts is inheritance tax mitigation.
Friends Provident International (FPI) offers a number of trust structures that
have been designed to reduce the exposure to Inheritance tax. A number
of these structures allow the creator of the trust to have access to all, or a
proportion of, the trust capital. All of our IHT plans combine a trust with an
offshore bond.
The decision tree on page 15 summarises FPI’s trust range and acts as a
simple guide on when to use which trust.
A trust can be used to preserve wealth for future generations. By placing
assets in trust, the creator of the trust (the settlor) can provide a degree of
financial security for the immediate family and beyond. A suitable trust can
give parents and grandparents peace of mind as regards the well-being of
future generations.
A trust allows the settlor to determine (through the trust deed) how the trust
assets should be distributed in the future. This is especially useful where the
beneficiaries are minors as it allows the trustees to determine when and to
whom the benefits will be paid.
iht planning using trusts
13
Why use an offshore investment bond?
As a trust asset, an offshore investment bond can provide significant tax and
administrative benefits. FPI is a tax exempt insurance company based in the Isle of
Man. We do not pay any income tax, capital gains tax nor corporation tax in respect of
the policyholders’ funds. With the exception of certain withholding taxes which may be
deducted at source on dividend payments, once invested, the investment capital can
accumulate entirely free of tax
Offshore investment bonds are non-income producing assets. Therefore, in the hands
of UK resident trustees they do not generate an ongoing income tax or capital gains
tax charge. A tax charge only arises when benefits are taken. An offshore bond is a
trustee-friendly asset as it relieves many of the accounting and administrative burdens
of the trustees.
The tax charge for offshore investment bonds written under trust will usually fall on the
settlor of the trust. This in itself may present a number of opportunities, for example the
settlor may be a non-tax payer as a result of being resident outside of the UK.
Where the settlor is deceased or non-resident the tax charge will fall on the trustees. If
the trustees are outside of the UK, then the tax charge will fall on UK beneficiaries, but
only when they receive benefits.
Benefits can be extracted tax efficiently by utilising the 5% withdrawal allowance and by
assigning individual policies to beneficiaries to encash. For more details please contact
your financial adviser.
14
Bare trust or discretionary trust
A bare trust, or absolute trust, is one in which each beneficiary has the absolute right
to the trust capital and income. The beneficiaries of a bare trust have the right to take
possession of the trust property on reaching the age of 18 (England and Wales).
The creation of a bare trust is a Potentially Exempt Transfer (PET) and therefore not
subject to the ‘relevant property’ regime. Any tax on the income of the trust is charged to
the beneficiaries if they are over 18 and the assets form part of the beneficiaries’ estate
for IHT.
A discretionary trust, or flexible trust, is subject to the ‘relevant property’ regime. The
gift into trust is a ‘chargeable lifetime transfer’ chargeable at a rate of 20% over and
above the Nil Rate Band (NRB).
There is also a 10 year periodic charge of 6% (over the then NRB) and an exit charge
when capital leaves the trust.
Which trust?
The choice of trust will depend on the individual’s financial and family circumstances.
An absolute trust will be useful where the settlor needs to make large gifts (over the
NRB) to reduce inheritance tax and where the donor is confident that he/she will not
need to change the beneficiaries.
The drawback is that the beneficiaries cannot be changed and can demand the trust
property at age 18.
A discretionary trust will be useful where the settlor wants the control over who will
benefit and when, which may include the settlor.
The drawback is that the discretionary trust is subject to the relevant
property regime.
However, a discretionary trust may be worth considering where the value
of the transfer will not exceed the nil rate band, or is within the available
exemptions.
Furthermore, where the only asset is an FPI insurance contract and the
settlor is non-UK domiciled, the UK relevant property regime will not apply.
iht planning using trusts (continued)
FPI’s range of trusts
• The Gift Trust
• The Loan Trust
• The Capital Access Trust
• The Discounted Gift Trust
15
trust planning decision tree
Are you willing to give up total access to the capital invested?
Do you wish to retain the ability to change beneficiaries?
Consider the Discretionary
Gift Trust
Consider the Absolute Gift Trust
Are you willing to give up access to a portion of the capital invested?
Do you wish to retain the ability
to change beneficiaries?
Do you wish to have all the capital outside of your estate after 7 years?
Consider the Discretionary Capital Access
Trust
Consider the Absolute
Capital Access Trust
Do you wish to retain the ability
to change beneficiaries?
Do you wish to retain the ability
to change beneficiaries?
Consider the Discretionary Discounted
Gift Trust
Consider the Absolute
Discounted Gift Trust
Consider the Discretionary
Loan Trust
Consider the Absolute Loan Trust
YES YES
YESYES
YESYES
YES NO
NONO
NO NO
NO NO
16
the discretionary gift trust
The Discretionary Gift Trust
Gifting assets to reduce the value of an estate is still the simplest and most effective
form of inheritance tax planning. Transferring assets into a Discretionary Gift Trust
enables the settlor(s) to transfer assets from their estate, the value of which, will be
outside of the estate for IHT purposes, providing the settlor survives seven years
from the date of the transfer. Any growth in the value of the transfer is also outside
of the estate.
Whilst the trust contains a wide class of beneficiaries, the settlor(s) are not beneficiaries
so as to avoid the Gift with Reservation rules. The settlor(s) can, however, be trustees.
The Discretionary Gift Trust is useful for individuals who have used all of their IHT
exemptions, but still have a large IHT liability. Providing the settlor is happy to give away
assets, and give up access to those assets, the Discretionary Gift Trust will remove the
capital from his estate, but will allow them to control its distribution.
Summary of benefits
• The ability to make gifts potentially free
of IHT
• Control over who will receive benefits
and when
• Flexibility to add or remove
beneficiaries at any time
• Investment growth free of IHT.
17
example
the discretionary gift trust in action
Doris Knight’s two children are becoming more and more concerned about the potential
inheritance tax on their inheritance. Doris, who is 71, inherited the house and a number
of large deposits from her husband John some three years ago — a total estate of £2
million. Fortunately, at the time, no IHT was payable when John died because of the gifts
between spouses exemption.
Doris’s Financial Adviser has given her a breakdown showing the extent of the
inheritance tax liability, which comes as quite a shock. The Financial Adviser also
suggests a number of possible solutions. The good news is that John’s unused nil rate
band can now be carried forward for Doris to use, which will certainly ease the problem.
Unfortunately, Doris has a slight health problem, which means that the cost of insuring
the IHT liability at her age is prohibitive. Fortunately, Doris is quite comfortably off.
She has far more income than she needs, which means she could reduce her estate
considerably without it affecting her normal standard of living.
The Financial Adviser suggests that she uses some of the IHT exemptions,
in particular her unused annual allowances, and make some transfers to her
grandchildren using the gifts out of income exemption. He also recommends
that she reduce the IHT liability over the next seven years by investing some
of her capital into an FPI offshore investment bond, and gift the bond into a
Discretionary Gift Trust – which she does. She keeps the gift within her nil rate
band to avoid the charge to lifetime IHT.
Doris is the settlor of the trust and also a trustee. She appoints her two children
as trustees and writes the bond on the lives of her four grandchildren. The
immediate beneficiaries are her children and the discretionary beneficiaries
include her grandchildren. Doris is not a beneficiary as this would be a gift
with reservation, and would not work for IHT planning. If, as is expected, Doris
survives seven years, the value of the Discretionary Gift Trust will be outside of
her estate and free from IHT.
18
The Discretionary Loan Trust
Loan trusts are suitable for individuals who need to do some IHT planning but are not
prepared to give capital away. The creation of a Discretionary Loan Trust is not a gift
for IHT purposes so is not a chargeable lifetime transfer. However, the 10-year periodic
charge could apply if the investment growth is in excess of the then NRB
How it works
The plan involves the settlor creating a flexible trust for the benefit of specified
‘named beneficiaries’, with the power to appoint benefits to a wide class of potential
beneficiaries. The trust is created with a lump sum, which is provided in the form of
an interest free loan to the trustees, which is repayable on demand. The trustees then
invest the capital in an FPI offshore investment bond.
The settlor will have access to the capital in the form of
loan repayments by the trustees. If the loan repayments
are kept within the 5% per annum withdrawal allowance,
the payments will not be taxable on the settlor at the
time they are taken. As each loan repayment is taken and
spent, the value of the settlor’s estate gradually reduces.
Any outstanding loan amounts remain part of the settlor’s
estate for IHT purposes. Any growth in value of the
offshore investment bond is held for the benefit of the
beneficiaries and is free of IHT.
Summary of benefits
• Only the value of the outstanding loan
forms part of the settlor’s estate –
‘estate freezing’
• All growth on the capital is immediately
outside the settlor’s estate
• The settlor has access to the whole of
his original capital
• The settlor has access to payments on
a regular or irregular basis
• The settlor can nominate specific
beneficiaries
• The settlor retains influence over
destination and timing of benefits.
the discretionary loan trust
19
example
the discretionary loan trust in action
Pete Brown is 48 years old, and married with two adult children. He is a senior
investment analyst with a leading fund management group. A keen investor himself,
he is well aware of the benefits and tax-efficiency of an offshore bond wrapper. He has
been dealing with a local Financial Adviser and has agreed to invest into an FPI offshore
investment bond using his firm’s discretionary management service.
Following the fact find, the Financial Adviser advises Pete and his wife to start thinking
about the effects of inheritance tax. Their jointly-owned property and current assets are
already in excess of their nil rate bands. So the liability is likely to increase over time.
They discuss a number of options, including estate reduction. At this stage, Pete
is not prepared to give assets away to reduce IHT. He still wants access to the
capital. But he does agree that gifting capital could be an option for the future.
As an alternative, the Financial Adviser suggests they look at the cost of insuring
the present IHT liability, and consider ways of reducing the effects of IHT in the
future. The Financial Adviser explains the merits of setting up a Discretionary
Loan Trust along side the FPI investment.
Setting up a Discretionary Loan Trust is not a gift for IHT purposes and therefore
not a chargeable lifetime transfer. The loan that Pete makes to the trustees will be
interest-free and repayable as and when Pete decides. Whilst the outstanding loan
stays within the estate for IHT purposes, any growth in the investment over and
above the initial loan is for the beneficiaries, and immediately outside of the estate.
In addition, if Pete takes the loan repayments to spend as income, this will also
have the effect of reducing the estate.
Pete sets up the FPI Discretionary Loan Trust appointing himself, his wife and
two children as trustees. He also appoints the children as named beneficiaries.
The trustees use the loan to invest in the FPI offshore investment bond. Pete
instructs the trustees to repay the loan using the offshore investment bond’s
5% per annum tax-deferred allowance. Pete can if he wishes stop the loan
repayments. He might also decide in the future to forgo the outstanding loan
and gift the capital on to his beneficiaries. The gift will then be outside of Pete’s
estate after seven years.
20
the discretionary capital access trust
The Discretionary Capital Access Trust
It is often the case when discussing inheritance tax planning that the individual, whilst
happy to give away certain amounts of capital, is not willing to give up access to the
income that is generated from the capital. On the other hand, it might be that income is
not an issue, but they want to retain a portion of the capital for that rainy day emergency
to cater for the unexpected. If either of these scenarios is an issue then the Discretionary
Capital Access Trust may be the solution.
How it works
The investor establishes a flexible power of appointment trust where the trustees hold
property on a specified trust, which comprises two parts:
The settlor’s capital entitlementThe settlor declares an amount of money that he wishes
to be held for his absolute benefit under the trust. This can
be any figure between 10% and 90% of the original capital
investment and is expressed as a fixed capital sum rather
than a percentage. The amount retained will depend on
the settlor’s likely future requirements.
The settlor can then:
• take regular capital payments from the
entitlement
• take ad-hoc payments of capital
• leave as an emergency fund
• revoke part or all of the entitlement if
subsequently the retained capital is not required.
Any amounts not taken and spent or gifted will form part
of the settlor’s estate for IHT.
The beneficiaries’ fundThis part of the trust fund is held for the named
beneficiaries, normally the settlor’s children or
grandchildren or for any of the Potential Beneficiaries, which may also include the settlor’s
spouse. The settlor cannot benefit from this part of the trust, which means the transfer is
a chargeable lifetime transfer for IHT purposes.
Summary of benefits
• All investment growth is immediately
outside the settlor’s estate
• The gifted part is completely outside
the estate after seven years
• Access to the retained part may be
taken as regular or irregular payments
• 5% withdrawal entitlement based on
the whole capital amount
• Flexibility to make further gifts from
the retained part
• Ability to control who receives benefits
and when they receive them
• The trust fund will not form part of the
beneficiaries’ estate for IHT.
21
example
the discretionary capital access trust in action
Henry, who is 53, has been an actor for a number of years. He is married with
one daughter who is at university. He lives in a four-bedroom period cottage in the
New Forest.
His Financial Adviser has presented an inheritance tax report and suggested a number
of ways of reducing his estate immediately using IHT exemptions. Over the longer-term
the Financial Adviser has suggested a reduction of the estate by taking advantage of the
seven-year gift period.
However, at this stage Henry is reluctant to part with all of his capital. But he is prepared
to gift some of his assets away bearing in mind the main beneficiary of his estate will
be his daughter. The Financial Adviser asks Henry to consider the Discretionary Capital
Access Trust.
The benefit of the Discretionary Capital Access Trust for Henry is that he can
decide what percentage of the trust capital he wants to gift away and the
percentage he wants to retain for his own use. The gifted portion of the trust is a
chargeable lifetime transfer, and it will be outside of his estate after seven years.
It is also a flexible trust for the benefit of his daughter and other discretionary
beneficiaries. Henry is advised to keep the gifted portion to below his nil rate band
(and annual allowance) to avoid the IHT lifetime charge.
The retained portion of the trust is a bare trust for Henry’s own benefit. He can, if
he wishes, draw down and spend the capital using the tax-deferred withdrawals
from the FPI offshore investment bond. What’s more, he can take up to 5%
per year of the original investment for the number of years the retained portion
reflects. For example, if Henry retains 50% of the investment, he can withdraw
5% per year of the original investment for 10 years (i.e. 10% per year of his
retained portion).
Another benefit for Henry is the flexibility to gift the retained capital onto the
beneficiaries over a number of years. This can be done tax-effectively using the
annual exemption and his new nil rate band after seven years.
22
the discretionary discounted gift trust
The Discretionary Discounted Gift Trust
Transferring assets into a Discretionary Discounted Gift Trust (DDGT) enables the
settlor(s) to reduce the value of their estates for inheritance tax purposes, and still
have access to the assets by way of regular capital payments. The trust is suitable for
individuals who have a liability to IHT and are happy to make substantial gifts, but need
access to regular payments to maintain their standard of living.
How it works
The settlor(s) effect an FPI offshore investment bond, and
set up the right to receive annual capital payments up to
5% per annum of the original capital. The policy is then
assigned into trust, which is split into two parts — the
settlor’s fund, and the beneficiaries’ fund. The settlor’s
fund provides that, should they be alive on each trust
anniversary, they will receive a capital payment, chosen
at outset by them and expressed as a percentage of the
original investment. The settlor(s) will be entitled to capital
payments whilst they are alive.
The value of the beneficiaries’ fund, together with any
growth, will fall outside of the settlors’ estate after
seven years.
Discounted Value
Carving out the contingent rights to capital payments in
this way gives an immediate reduction in the settlor’s
estate by way of a discount on the value of the gift for IHT
purposes. This means that there is an immediate reduction
in the IHT liability should the settlor die within seven years
of creating the trust.
Summary of benefits
• Immediate reduction in the settlor’s
estate by way of a discount for IHT
purposes
• The trust enables the settlor to make
a substantial gift and the beneficiaries
to enjoy tax free growth on the
investment
• The settlor has the right to receive
fixed regular cash payments during
his lifetime or until the death of the
surviving settlor if joint settlors
• The option to have husband and wife
as joint settlors (assuming both are
UK-domiciled)
• The trust can be used with any FPI
product. This enables the trustees to
defer tax until a chargeable event is
created.
23
example
the discretionary discounted gift trust in action
Divorcee Jane Critchley, 76, has lived in the same house for over 30 years. She has
seen her property rocket in value over the last 10 years. The house, together with her
investments, means that she is now well into the inheritance tax bracket.
During a consultation with her Financial Adviser, she explains her reluctance to give up
the access to capital. Whilst she agrees with the Financial Adviser that she needs to
make gifts of capital to reduce her estate over the next seven years, she is reluctant to
do so if it lowers her standard of living. The Financial Adviser explains to her the benefits
of a discounted gift trust.
Jane creates an FPI Discretionary Discounted Gift Trust, carving out a
contingent interest of up to 5% per annum from the offshore investment bond.
Jane, as the settlor of the trust, is automatically a trustee.
The contingent interest gives Jane a regular payment each year of up to 5% of the
original investment for as long as she lives. Should she die within the first seven
years, the value of the gift will be discounted, which will reduce the amount of
IHT paid. The amount of discount is determined by her age and state of health at
the time that she creates the trust. After seven years, the initial gift will be outside
of her estate for IHT purposes. Any growth in the investment is outside of her
estate immediately.
24
wills & intestacy
Reasons for making a will
It is very important for everyone to make a valid will and to review it regularly, especially
where personal circumstances change, such as getting married (CP), getting divorced,
or having children or grandchildren. Failure to make a will means that an individual would
die intestate, which means that the estate would be distributed in accordance with the
“rules of intestacy”. This could result in the estate not being distributed in accordance
with the deceased’s wishes.
In addition to avoiding the rules of intestacy, there are a number of personal reasons why
an individual would want to make a will, and could include the following:
• to distribute their assets and personal effects in accordance with their wishes
• to make provision for their children regarding guardianship and how they will be
provided for
• to indicate their funeral requirements
• to help reduce death duties
• to make provision for their pets
• to leave money to their favourite charity
• make provision for the nil rate band:
– to leave all to the spouse (CP), or
– controlled distribution with a trust.
25
Intestacy
A person who dies without leaving a valid will is said to have died intestate. In this case,
the estate of the deceased is distributed in accordance with the law of intestacy, which
means that the distribution of the deceased’s assets will depend on whether there is a
surviving spouse (CP), whether there are children or grandchildren, or whether there are
other blood relatives of the deceased. In England and Wales, the estate of a person dying
intestate will pass as follows:
• A surviving spouse (CP) and children
The surviving spouse (CP) will receive the deceased’s personal belongings and a
statutory legacy of £250,000. The spouse (CP) will also receive a life interest in
half of the remaining estate.
The children receive half of the residual estate in equal shares when they reach the
age of 18, and the other half of the estate on the death of the surviving spouse.
If any of the children have died then their children will receive their parents’ share
(per stirpes).
• A surviving spouse (CP), no children or remoter issue
The surviving spouse (CP) will receive the deceased’s personal belongings and a
statutory legacy of £450,000, and half of the residual estate absolutely.
The other half of the residual estate will pass to the parents of the deceased;
if none, to brothers and sisters or issue; if none, to nephews and nieces of the
deceased; if none, to the spouse.
• No surviving spouse or children or remoter issue
The estate will pass to the parents; if none, to full-brothers and sisters and issue;
if none, to half-brothers and sisters and issue; if none, to grandparents; if none, to
full-uncle and aunts or issue; if none, to half-uncle and aunts or issue; if none, to
the Crown.
26
glossary of terms
ABSOLUTE TRUST A trust for the exclusive benefit of one or more beneficiaries in
specified shares. The beneficiaries become entitled to their share of the trust property on
reaching age 18. Also known as a Bare Trust.
ANNUAL EXEMPTION The amount that a person can give away each tax year that will
be exempt from IHT. This is currently £3,000 per year.
BARE TRUST See Absolute Trust.
BENEFICIARY A person or organisation who may benefit from a will, intestacy or a trust.
CONTINGENT INTEREST An interest in trust assets which becomes a vested interest
only on the happening of a certain event.
DEEMED DOMICILE A legal concept for inheritance tax purposes where a non-UK
domiciled person is treated as if they were domiciled in the UK at the time of a transfer.
The person will be deemed domiciled if they have been resident in the UK for 17 out of
the last 20 years.
DISCRETIONARY TRUST A trust in which no beneficiary has the right to an interest in
possession, the trustees having the power to decide who will receive income and capital
from the trust.
DOMICILE A concept of law which refers to the country that a person would refer to as
his permanent home. For UK IHT purposes, a person’s domicile may be different from
his or her residence.
ESTATE for IHT purposes means the combined total of a person’s assets and property
on death.
EXCLUDED PROPERTY covers certain types of property, which, subject to certain
conditions, does not form part of a person’s estate for IHT purposes.
EXEMPT TRANSFER A lifetime transfer of value that is exempt from IHT by virtue of it
being covered by one of the exemptions.
EXIT CHARGE The tax charge made when there is a distribution from a discretionary
trust. The calculation is based on 30% of the lifetime rate of IHT (currently 20%), i.e.
maximum 6% depending when the exit charge arises.
FLEXIBLE TRUST A trust where named beneficiaries have an immediate entitlement to
trust income, but the trustees have total discretion over the appointment of capital.
27
GIFT WITH RESERVATION A gift ‘with strings attached’, i.e. a gift where the donor
continues to enjoy the benefits of the gift. A gift with reservation will remain within the
donor’s estate for IHT purposes.
GRANT OF PROBATE is a legal document which allows the person(s) named in it to
collect and distribute the assets of a deceased person’s estate.
INTEREST IN POSSESSION The immediate right to enjoy the trust property or receive
income from it. The interest can be revocable or irrevocable.
JOINT TENANCY A form of joint ownership, where all parties have an equal share of
the property. On the death of one owner, their interest passes to the remaining owners.
NIL RATE BAND The amount of a person’s estate on which there is no charge to IHT.
PER STIRPES Property that is to be divided among the children of a deceased person,
where each child takes an equal share. If a child has predeceased the deceased, then
that child’s children will take equally between them the share that the predeceased child
would have taken.
PERIODIC CHARGE An IHT charge on a discretionary trust on the 10th anniversary of
the trust, and every subsequent 10 year anniversary.
POTENTIALLY EXEMPT TRANSFER (PET) A transfer of value between individuals, or
to a bare trust or to a trust for a disabled person, which is outside of the donor’s estate if
the donor survives seven years.
RELEVANT PROPERTY refers to property to which the periodic and exit charges apply.
All property settled on a discretionary trust is relevant property.
REMOTER ISSUE Grandchildren, great grandchildren (and so on) of the deceased.
SETTLOR The person who creates the trust.
SETTLEMENT See Trust.
TENANTS-IN-COMMON Joint ownership of property, where each owner has a distinct
share of the property, the value of which forms part of their estate.
TRUST A legal arrangement whereby the creator of the trust transfers property to
another person(s) [the trustee(s)] to hold for the benefit of another person(s) – the
beneficiary(ies).
XIM21/GUIDE 01.14 (41406)
Friends Provident International Limited
Registered and Head Office: Royal Court, Castletown, Isle of Man, British Isles, IM9 1RA. Telephone: +44(0) 1624 821 212 Fax: +44(0) 1624 824 405 Website: www.fpinternational.com
Incorporated company limited by shares. Registered in the Isle of Man, number 11494. Authorised by the Isle of Man Insurance and Pensions Authority.
Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. As Friends Provident International Limited is a non-UK based insurer, the regulatory system that applies, in some respects, is different from that of the United Kingdom Provider of life assurance and investment products. Friends Provident International is a registered trade mark of the Friends Life group.
The information given in this document is based on Friends Provident International’s
understanding of UK and Isle of Man tax law and HM Revenue & Customs practice as
at December 2012, which may change in the future. Individuals are advised to seek
professional independent advice and no liability can be accepted for the personal tax
consequences of this Trust or for the effect of future tax and legislative changes.
Investment involves risk and each class of investment will involve its own individual
level of risk. We recommend that you discuss specific risks associated with individual
investments with your financial adviser before making any investment decisions.
Each policy is governed by and shall be construed in accordance with the law of the
Isle of Man.
All policyholders will receive the protection of the Life Assurance (Compensation of
Policyholders) Regulations 1991 of the Isle of Man, wherever their place of residence.
Investors should be aware that specific investor protection and compensation schemes
that may exist in relation to collective investments and deposits accounts are unlikely
to apply in the event of failure of such an investment held within insurance contracts.
Complaints we cannot settle can be referred to the Financial Services Ombudsman
Scheme for the Isle of Man. (Not applicable to Corporate Trustees.)
A written statement of the policy terms and conditions of the products may be obtained
from Friends Provident International on request.
Some telephone communications with the Company are recorded and may be randomly
monitored or intruded into.
Copyright © 2012 Friends Provident International Limited. All rights reserved.