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Considerations for trustees when contemplating a payment to a beneficiary of a Discounted Gift Trust (DGT) while the settlor is still alive.
· The settlor/donor is not a beneficiary of a DGT so care must be taken to ensure that person doesn’t benefit directly or indirectly from the payment.
· The trustees can distribute part of the trust fund to a beneficiary if the settlor’s/donor’s rights to the pre-selected payment stream aren’t adversely impacted.
· The tax consequences of the distribution must be considered.
Payments in settlor’s lifetime
Many discretionary DGTs have a facility allowing the trustees to make a payment to a beneficiary during the settlor’s/donor’s lifetime. This is intended to be used only in an ‘emergency’ – where a beneficiary is in urgent need of funds (perhaps following a business failure or on a divorce).
The settlor/donor is not (and cannot become) a beneficiary of a DGT so great care must be taken to ensure that the settlor/donor does not benefit directly or indirectly from the payment.
How does the trust deed permit such an advance?
Example trust wording
Power of advancement
Subject to the settlor’s rights, the trustees may pay any trust property to any of the beneficiaries for the advancement or benefit of the beneficiary or beneficiaries concerned.
This is usually qualified by a provision similar to the following:
Trustees’ powers subject to settlor's rights
None of the trustees’ powers shall be exercisable in any way that would reduce the value (whether directly or indirectly) or extent (whether directly or indirectly) of the settlor’s rights to capital or otherwise impede, or negate or adversely affect the ability of the trustees to meet payments arising in respect of the settlor's rights as they become due. This restriction shall cease on the settlor’s death.
Similarly, with an Absolute DGT the trustees will be obliged not to exercise any power that will adversely affect the donor’s rights.
What does this mean?
The trustees can distribute part of the trust fund to a beneficiary if the settlor’s/donor’s rights to the pre-selected payment stream aren’t adversely impacted.
Whether or not the settlor’s/donor’s rights are adversely affected by a distribution to a beneficiary is a matter for the trustees to determine.
An ‘over-distribution’ (i.e. one which would adversely impact the settlor’s/donor’s rights) would be a breach of trust. The trustees would be personally liable for any shortfall should the settlor’s entitlement not be fulfilled.
How can this distribution be effected?
The distribution could be by way of:
partial surrender across all policy segments followed by distribution to beneficiary.
What are the tax consequences of a distribution?
If route (1) is adopted, the trustees will (in most cases) not be able to meet future payments to the settlor without breaching the 5% tax deferred allowance from the remaining segments. This will mean annual chargeable events. Any tax charge falls on the settlor of a discretionary trust. The settlor has a right of recovery from the trustees. If the settlor does not exercise this right he/she is treated as making a transfer of value for IHT purposes.
If route (2) is adopted, there will be an income tax chargeable event at the end of the policy year if the 5% cumulative allowance is breached. Any tax charge falls on the settlor of a discretionary trust. The settlor has a right of recovery from the trustees. If the settlor does not exercise this right he/she is treated as making a transfer of value for IHT purposes.
The distribution by the trustees to the beneficiary of a discretionary trust will be a transfer of value for IHT purposes (an ‘exit’ charge). In most cases the availability of the trustees’ nil rate band will mean that no IHT is immediately payable.
In the case of an Absolute DGT, if the trustees advance trust capital to a named beneficiary and accordingly breach 5% limits then the beneficiary will be assessable on the chargeable event gain on a just and reasonable basis.
It should be clear to trustees that emergency advances are a ‘solution of last resort’ and the tax and legal consequences need to be fully analysed before action is taken.