This month’s article from M&G, comes from Liz Hardie – Senior Technical Manager. Looking at replacing bonds in a DGT, Liz gives us five questions we should be asking before making the move.
Research tells us that the average age of the settlor of a Discounted Gift Trust (DGT) is early 70s. Based on current life expectancies, the settlor’s lifetime right to regular, fixed capital payments could last for at least 15 years.
An adviser reviewing an existing DGT linked to an older investment bond might be tempted to replace it with a newer investment bond proposition, offering a digital journey, wider investment options and more segments.
Perhaps the fixed regular payments out have seen the underlying investment ravaged by sequencing risk, endangering the future payment stream and reducing what is left for beneficiaries.
At first glance, replacing the existing bond may look like a straightforward decision. It’s not… the settlor’s rights are the main objective of a DGT, any change needs to preserve these, while also dealing with product, tax and trustee implications.
Here are five points to consider before making a move:
1. Check the proposed change can actually be made
Establish exactly what the trust deed and policy T&Cs allow, some DGTs and bond packages have restrictions.
While most trust provisions give trustees wide investment powers, the existing policy T&Cs must allow it to be surrendered, and many don’t while the settlor is alive.
The settlor’s rights could be carved out of the policy not the trust, often the case with absolute DGTs. If the bond is surrendered, the settlor’s payment stream would stop. In addition to this loss of the payments, the value of the settlor’s retained rights are gifted to the trust causing potential inheritance tax (IHT) consequences.
If the change isn’t allowed then it’s a non-starter.
2. Protect the settlor’s retained rights
Can the replacement bond continue to support the settlor’s fixed capital payments? The payment amounts and frequency were set at outset and shouldn’t change unless the trust provisions specifically allow it. Do the new bond T&Cs allow a regular withdrawal of the appropriate size?
Tax wise, if the existing bond performed well, then the new premium may allow continued payments within the tax deferred allowance, but if the new premium is below the original premium, chargeable event complications can arise.
Any missed, or reduced, payments are usually treated as further gifts into the trust…again with possible IHT implications.
3. What about the 5% tax deferred allowance?
Older bonds reaching the 20 year point will stop accruing the 5% tax deferred allowance (TDA), and may start to enter annual excess chargeable gain territory.
Excess gains on single settlor trusts may not be an issue. If it’s an onshore bond, where the settlor is a basic rate taxpayer, small excess gains could be absorbed without a tax impact, so why move?
Alternatively…Charles and Elizabeth Baskerville are joint settlors of a discretionary trust, Elizabeth has died in a previous tax year. Here, any excess gains would be split and assessed 50% on Charles and 50% at trustee rate.
There could be a tax saving in replacing a bond that has performed well to rebase the 5% TDA on a higher premium. Remember to factor in ongoing advice charge and check if integrated platform fees eat into the 5% TDA.
4. Consider the income tax consequences
To replace, the existing bond is surrendered and the proceeds reinvested into the new bond.
The income tax consequences of the surrender chargeable event need to be considered and justified. Who is assessed, the rate of tax and whether top-slicing relief is available will depend on the trust structure and the circumstances at the time:
– John and Mary Watson are joint settlors of a discretionary DGT, both are basic rate taxpayers. John and Mary are lives assured on the bond and it’s set up on last death basis. If John dies, replacing their existing bond that tax year realises a chargeable gain and John’s share would be assessed at his rate of tax. Leaving it to a later tax year means suffering trustee rate of tax on his share.
– Irene Adler is the sole settlor of a discretionary DGT and a higher rate taxpayer. While moving to a bond with lower charges would give an annual saving, the chargeable gain on surrender of the bond could mean she loses her personal allowance and cause her a significant tax charge.
5. Is the move right for the trust?
Consider the suitability of the existing bond.
The existing bond may not have as many segments but if only a few children and grandchildren will benefit, will the availability of more segments in a new bond matter?
If the investment options within the current bond meet the trustees’ objectives, will a new bond with wider investment choices benefit them?
Five questions to ask
Get your underpinning investment right in the first place so investment matters don’t “force a move”. Regardless of the reason for moving before recommending replacement of a bond inside a DGT, ask five questions:
1. Can the trust and provider T&Cs accommodate the change?
2. Can the settlor’s retained rights continue completely unchanged?
3. What chargeable event gains will be triggered?
4. Who’ll be assessed on those gains?
5. Can the benefit of replacing be demonstrated?
Main image: notepad, diana-polekhina-1ixT36dfuSQ-unsplash
