My wife has been advised to take out a discounted gift plan to avoid future inheritance tax (IHT). A trust would be set up and her two sons would be made trustees.
We have been told that on an investment of £200,000, there would be an initial saving of £67,100 on IHT and after seven years the fund would be completely exempt. My wife, who is 77 years old, would receive an annual income of £8,000 tax- free under the scheme.
There is an annual management charge of 1.98%. The question is, are there any disadvantages to a discounted gift plan?
A discounted gift plan allows your wife to set up a trust and then transfer money out of her estate into the trust to be managed by trustees for the benefit of her beneficiaries.
In this case, your wife would be retaining a benefit by receiving set capital withdrawals throughout her life.
It is the value of these future withdrawals that is used to create a ‘discount’ for IHT purposes. This is because the money is intended to be given back to her during her lifetime.
As it is impossible to know exactly how long a person will live, certain assumptions are made about factors such as age, health and the level of withdrawals agreed, and then the amount expected to be paid out is calculated. On researching the market, a healthy 77-year-old woman taking £8,000 a year withdrawals could see a discount of broadly 38% (£76,000 in this case subject to underwriting).
This translates as an IHT saving of 40% of that amount, so £30,400.The remaining balance of the trust at £124,000 would be classed as a gift and would fall completely outside of the estate for IHT purposes if your wife lives a further seven years.
While the advantages of this plan can be seen in the immediate savings on IHT, that is reliant on the discount being allowed by HMRC. The discount is not guaranteed and will be down to a decision by HMRC if your wife dies within seven years of the plan being set up.
As with any gift, your wife needs to be comfortable that she is letting go of the capital sum forever and, depending on which type of trust is used, potentially losing a significant element of control over what happens to the money.
Finally, the trust would need to be invested wisely to make sure it grows enough so that the returns exceed the withdrawals being given back to your wife. If the overall capital erodes, then the whole strategy would have failed.