Generate an income after retirement whilst protecting your family

With the equity, available for release in UK homes rising to £500 billion, more people of 55 or over are considering how they can access some of this capital.  However, it’s important to consider why you might want to do this and there may be many reasons why extra capital could make a huge difference to your retirement plans.

Some people might want to use the capital to make a specific purchase, or to carry out some home improvements, however, it’s more likely to be needed to help improve income if your own pension income is not sufficient to cover your expenses.  The shortfall may be down to having to retire sooner than expected due to redundancy, or it may be that your pension has not performed as expected but whatever the reason, releasing some capital from your property could help fill any shortfall.

At the same time as releasing capital to provide a boost to your income, by placing the capital into a Discounted Gift Trust (DGT), you can help reduce your exposure to Inheritance Tax (IHT).

Discounted gift trust – how it works

A person’s total assets can push them through the IHT barrier of £325,000 and in many cases, it is the value of their home that causes the problem. If the property is passed to direct descendants there is an additional £175,000 allowance called the Residence Nil Rate Band.

One of the most difficult challenges in IHT planning is protecting a property, as you would need to give the house away and not get any benefit from it (such as living in it), for HMRC to regard it as outside of your estate.   However, if you obtain a Lifetime Mortgage it sets up a debt that you will never need to clear until after your death.  This will reduce the value of the property in the estate and the capital released in this way can be placed in a DGT to increase in value until it passes to your beneficiaries on death and will be outside of your estate and therefore, tax free.  One useful feature is that the interest chargeable will be added to the mortgage debt thus reducing the Inheritance Tax bill even further.

In addition to a property, many people may also have sizeable cash savings or investments and by placing them in a DGT they can gain some inheritance tax relief.

The DGT allows you to gift a lump sum into a trust whilst retaining a lifelong ‘income’ from the money (technically withdrawals of capital), with the aim of reducing the eventual IHT payable on death.

As the income is a withdrawal of capital, it means that if regular withdrawals are no higher than 5% of the original investment and the total amount withdrawn in your lifetime does not exceed 100% of the original investment, there will be no immediate liability to income tax.

If, or when, the limits are exceeded then a tax charge may apply.  In addition, provided the investor is in reasonable health, a calculation is made of the likely total amount of ‘income’ that will be paid during their lifetime.  The likely total income is then given a capital value, usually known as the “discount” and is said to be retained by the client.

In the event of the investor’s death, this “discount” should in theory be returned to their estate and evaluated for IHT. However, the accepted IHT treatment, which has been tested many times and accepted by HMRC, is that this right to an income for life has no value once the settlor has died, and therefore no money needs to be returned.

The effect is that the discount is considered to have left their estate on day one providing an immediate IHT benefit. The possibility of an immediate IHT saving while retaining access to an income stream is extremely attractive.

All cases will be different and will depend on the individual’s own personal circumstances and below we have a basic example of how the Discounted Gift Trust can work.

  • A man aged 70 puts £100,000 into a Discounted Gift Trust.
  • He aims for 5% income (£5,000 p.a.) from a bond and has a life expectancy of nine years.
  • The insurer will calculate 5% of £100,000 times nine years, giving £45,000.
  • The client starts taking his income, and from day one of the trust, the £45,000 will be outside his estate for IHT purposes.
  • The remaining £55,000 of the gift is viewed by the Revenue as a potentially exempt transfer (PET).

Lifetime of the settlor

The settlor’s right to the capital payments is for life or until the funds run out.

The trustees of a discounted gift trust (DGT) normally only make payments of capital to the beneficiaries after the death of the settlor (or both settlors in the case of a joint settlor plan). This is to protect the settlor by ensuring that, as far as possible, the trust has sufficient funds to meet the settlor’s entitlement to income (retained payments).

During the settlor’s lifetime, the trustees can normally only make withdrawals to pay the settlor’s entitlement, or to meet liabilities of the trust. This is the case regardless of whether an absolute, flexible or discretionary trust is used.

Placing your capital in a Discounted Gift Trust will give you an immediate reduction in IHT and freedom from IHT after 7 years whilst providing you with a regular fixed income at your chosen level.  Any growth in the investment immediately falls outside of the estate.

Birchwood will be holding a Webinar presentation in October to outline the relative merits of using Equity Release and a Discounted Gift Trust to provide an income, whilst reducing your exposure to IHT and ensuring more of your capital goes to your beneficiaries.

We will be sending out further details of the Webinar in due course but if you wish to discuss Equity Release and Discounted Gift Trusts, please contact your adviser who will be happy to go through details with you.



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Birchwood Investment Management Ltd,
8 Prospect Place, Welwyn, Hertfordshire, AL6 9EN

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