Low interest rates can cut your IHT bill
Philip Scott, This is Money, 4 March 2009Lower interest rates are doing savers no favours but cheaper money and changes made by the Government this week will potentially allow people to a slash a considerable sum off their inheritance tax (IHT) bill.
On Monday, HM Revenue & Customs confirmed that as a result of falling interest rates the amount of cash that can be put away in a tax wrapper known as a Discounted Gift Trust (DGT), without bringing with it an IHT charge, has risen by 13%.
DGTs are designed for people who do not need access to their capital and hope to pass it to their loved-ones free from IHT, but want to retain the right to draw a regular income.
Colin Jelley, head of tax and financial planning, at life insurer, Skandia, says: 'This is a significant improvement for savers and should increase the attractiveness of DGT structures for those who are trying to cut back their IHT liability but at the same time are looking for decent income in their old age.'
HMRC has announced that, due to falling interest rates, the rate of interest used for calculating the value of the investor's income from a DGT has reduced from 6.75% to 5.25%.
This will allow more to be invested in a DGT without creating an immediate IHT liability - and the part of any investment in a DGT that is liable to IHT will drop, in some cases by even up to as much as 20%.
How Discounted Gift Trusts work
A person's total assets push them through the IHT barrier and in many cases it is the value of their home.
However, many will have sizeable cash savings or investments and by placing them in a DGT they can gain some inheritance tax relief.
Once a DGT is set up, a percentage of the cash invested in the wrapper, based on a number of factors including how much money you have paid in, your life expectancy and how much income you wish to take, is then considered to be outside of your estate by the taxman. On death it can be passed on free of inheritance tax.
The rest of the cash - the gift - in the DGT can be used in two different ways and is liable for IHT. The new rules have lowered the amount that would be considered the gift.
If what is called a bare trust is established, it explicitly outlines your beneficiaries and the discounted gift is treated as a 'potentially exempt transfer' and comes out of your estate, if you live for a further seven years.
On the other hand a discretionary trust, gives the trustees greater discretion and flexibility over who will eventually benefit from the cash. In this instance the wrapper becomes what is dubbed a 'chargeable lifetime transfer'.
If the gift is above the IHT exemption threshold, which stands at £312,000 in this tax year, there will be an IHT bill to settle.
What the change means? Take a male aged 60, with £200,000 invested in a DGT. Assuming normal life expectancy, that he is a non-smoker and is taking 5% withdrawals, on a monthly basis, his previous 'gift' within his investment liable for IHT was £95,187. But as a result of HMRC's changes, this has been reduced by 15% to £80,875.
And for a female, also aged 60, with the same circumstances - the gift in her £200,000 DGT investment liable to IHT has dropped by 20% from £86,660 to £69,444 – 20% less, because of the changes.
