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.