Since the October 2024 budget, Inheritance Tax (IHT) has been a growing topic of conversation. Over the coming years, it’s estimated that Britain’s baby boomer generation – those born between 1946 and 1964 – will transfer wealth worth trillions to their beneficiaries. As a result, the demand for IHT advice is expected to rise.
Effective financial planning requires a cautious balance between multiple priorities, including:
- Income versus capital
- Access to funds verses long-term returns
- Planning for the future whilst ensuring financial security today
- Managing personal wealth alongside providing for future generations
A DGT can be a valuable tool in helping individuals navigate these considerations and find the right balance.
What is a DGT?
A DGT is structured as an Investment Bond (either onshore or offshore) placed within a trust. It allows individuals to gift capital to beneficiaries whilst retaining a right to receive fixed level of withdrawals, or a lifetime ‘income.’ A security of income provides individuals with financial reassurance, particularly for those concerned about the risk of depleting their assets too soon, which can sometimes delay effective estate planning.
An easy way to understand a DGT is through the analogy of a cake:
- The gift of capital invested into the trust via an Investment Bond is the cake itself. This amount is subject to the standard seven-year IHT rules for gifting.
- A portion of the cake is immediately set aside as the discounted amount – this ‘slice’ of cake represents the amount of capital required to deliver the individual’s withdrawals over their lifetime.
- This portion is not treated as part of the gift but instead acts as a discount to the gift and is considered an immediate IHT saving as it falls outside the taxable estate from the outset.
There are two key types of trust to choose from:
Discretionary Trust
Trustees have flexibility over how and when funds are distributed to the selected beneficiaries.
Absolute Trust
The beneficiaries are fixed at the outset and cannot be changed.
The ‘income’ withdrawn from a DGT is treated as returns of capital rather than taxable income. Provided that the withdrawals remain within the 5% annual allowance of the original investment, there is generally no Income Tax or Capital Gains Tax (CGT) to pay. However, any growth in the investment may eventually be subject to Income Tax once in the hands of the beneficiaries.
Key Considerations
Age and health are important considerations. The level of IHT discount applied is medically underwritten, meaning individuals in poor health may receive lower discounts than healthier individuals, reducing the immediate tax benefit.
Flexibility is also something to consider. Once a DGT is established, the withdrawal amount is fixed, meaning funds greater than the fixed lifetime income cannot be accessed. So, it is important to ensure that sufficient capital is retained elsewhere to cover any unexpected financial needs.
When is a DGT the right choice?
A DGT can be a highly effective estate planning solution, combining IHT savings with financial security. It is particularly well-suited for individuals who are willing to transfer part of their wealth to future generations whilst ensuring their own tax efficient financial stability.
Seeking professional financial advice is essential before setting up a DGT, as it is often most effective when used alongside other estate planning strategies.
In summary
A DGT offers an efficient way to manage wealth succession, providing an immediate IHT advantage while securing a structured withdrawal plan. However, as with any financial strategy, it is important to assess personal circumstances and long-term goals before proceeding. Consulting an experienced financial adviser will ensure that the approach aligns with both tax efficiency and financial security for the future.
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