Technical Connection answer queries on discounted gift trusts and benefit crystallisation events
Q I have a client who has a discretionary discounted gift trust (DGT), who wants to move the fund management to another provider. If the bond was surrendered and the proceeds re-invested, how would the trust be taxed?
If the bond was surrendered, any chargeable event gain would be assessed to income tax on the settlor, if alive and UK resident, and otherwise on the trustees at the trust rate (45% with a credit for basic rate tax if the bond is an onshore bond). If the settlor is assessable to tax, they have a statutory right to recover the tax paid from the trustees, who would need to fund the repayment out of the surrender proceeds. If the settlor does not exercise this statutory right of recovery (and it is not excluded by the trust deed), they would be treated as adding to the trust and this would affect the inheritance tax position.
Another issue would be that because the new investment amount would be different from the original investment amount, the regular withdrawal amount that is payable to the settlor from the DGT may not equate to an exact percentage of the new investment amount, so it may not therefore be possible to fix withdrawals from the new plan at the required level. This would cause a problem as it is not possible to increase or reduce the ‘income’ level under a DGT.
A possible solution would be to reinvest only so much into the bond as was invested into the original plan. However, the trustees would then need to decide what to do with any surplus investment growth. It may be possible to distribute this to beneficiaries and it would be necessary to consult the terms of the trust to check that there is no prohibition on such distributions during the settlor’s lifetime.
It is also essential to check the terms of the DGT as the trust deed could prevent the investments from being moved (some DGTs intrinsically link the trust terms to the original investment product).
Q When will a benefit crystallisation event (BCE) occur on the death of a pension scheme member and, if a lifetime allowance (LTA) charge applies, who pays it?
A BCE occurs where the member dies before the age of 75 and uncrystallised funds are designated within two years to provide a beneficiary’s drawdown or used to provide a beneficiary’s annuity. Therefore, while any payments to the beneficiary are free of income tax in these circumstances, an LTA charge can still apply. A scheme pension paid to a beneficiary will not be a BCE. However, the payments will be subject to income tax.
A BCE will also occur on any lump sum death benefit payment. In all cases, the scheme administrator will pay the death benefits without deducting an LTA charge.
The personal representatives are responsible for determining whether an LTA charge applies. They do this after the payment of the lump sum, the date of designation to drawdown, or the date the beneficiary becomes entitled to an annuity as appropriate.
Where the personal representatives identify an LTA charge, they must report this to HM Revenue & Customs (HMRC). HMRC will then assess the beneficiary on any charge due. The usual LTA charges will apply – 55% on any excess paid as a lump sum, or 25% on any excess used to provide income.
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