Discounted Gift Trusts (DGTs) are normally set up in conjunction with an onshore or offshore bond using the bond providers “off-the-shelf” trust. However, if the funds the client intends to use to establish the trust are already in a bond, should they gift the bond by way of assignment to establish the trust or surrender it and use the cash proceeds to set up the bond and trust?
BarrieDawson, senior technical manager, M&G Wealth, considers six important things to consider when assessing which route will provide the most suitable outcome.
1. The Bond provider
The first thing to check is the bond provider’s DGT procedures because while it’s possible to use an existing bond to establish a DGT, some providers will only facilitate the arrangement with a new bond.
2. Entry charges (discretionary DGTs)
Lifetime gifts into a discretionary DGT are Chargeable Lifetime Transfers (CLTs).
CLTs are cumulative and CLTs in the seven years prior to the current CLT will reduce the amount of nil rate band (NRB) available. If the proposed CLT exceeds the available NRB there is an immediate charge of 20% on the excess amount but generally most clients aim is to avoid an entry charge.
With a DGT the settlor’s CLT might be discounted depending on their age, health and the level of payments they require. Once the discount (if any) is known it’s easy to ensure the CLT is within the available NRB if using cash to set up a new bond). If an existing bond is used it’s important to ensure there isn’t a spike in the surrender value on the day the trust is executed.
For cash and existing bonds, don’t forget that if the settlor passes a birthday after notification of a discount, but before the DGT is set up, their discount will be reduced. If this happens a revised discount figure should be obtained and considered before the trust is established.
3. Existing bond gains
An existing bond is likely to have gains that have yet to be realised so if the client can realise the gains tax efficiently before establishing the trust then that will be the most tax efficient route.
If the client pays tax at the higher rates, but the ultimate beneficiaries are likely to be in lower tax brackets, then assigning the bond into the trust for those gains to be realised in the future by the beneficiaries post the settlor(s) death might achieve a better net return. Although this planning also needs to factor in the next important point on lives assured.
4. Lives assured
Bonds are often set up with a younger additional life assured. The most common reason is to avoid an immediate chargeable event on the owners death. This provides the opportunity to transfer the liability for gains to the trust beneficiaries as touched on in the previous key point.
This might not be as much of an issue for bare DGTs as the beneficiary would be assessed on the gain. However, it is important for discretionary DGTs. If the settlor is the sole life assured the gain would be assessed against them on their death (assuming they were UK resident). For joint settlor discretionary DGTs with both settlors as lives assured there’s a risk they die in different tax years in which case half the gain would be assessed at the trust rate of 45%.
If the life assured basis on an existing bond is not aligned to the chargeable event objectives then consider a new bond with younger lives assured. Or perhaps an offshore bond on a capital redemption basis (no lives assured).
5. 5% tax deferred allowance (TDA)
If an existing bond is used to set up the DGT then some of the 5% TDA might have been used. This could mean the settlors regular payments lead to excess gains being triggered during the settlors lifetime so the tax implications needs to be carefully assessed. And there’s a quirky rule with bare DGTs to remember too. If gains occur as a result of meeting the settlors payments, that gain will be assessed against the settlor, not the bare beneficiary.
Surrendering the existing bond and setting up the DGT with a new bond will create a new 5% TDA tranche which might be a better chargeable event strategy. Furthermore, if the surrender proceeds (less any initial adviser charge) are greater than the original bond investment value, the 5% TDA on the new bond will be greater than the original bond.
6. Segmentation
The number of segments on an existing bond might be low which could impact future chargeable event planning. If there are more segments then smaller gains can be crystallised which can be useful when trying to maximise tax efficient use of the tax bands and avoid tax traps.
If the intention is to assign segments of the bond to trust beneficiaries, will the number of segments on an existing bond be compatible? For example, if three beneficiaries are to get an equal split, this can’t be achieved if the existing bond only has 20 segments.
If a new bond is used then then an appropriate amount of segments can be created to achieve the chargeable event and distribution to beneficiary objectives.
Summary
There are other factors to consider such as fund choice, product/fund charges etc, but careful analysis of the above points will be key to making a decision.
