Trust Estate

GUEST ARTICLE: Trustees' Duties Under A Discounted Gift Trust

Kim Jarvis, 8 May 2017

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A discounted gift trust allows a client to put a lump sum into trust for their chosen beneficiaries, while retaining the right to regular fixed payments. This article examines some of the duties such structures entail.

This news service is carrying a number of items from Canada Life, the financial services group, on specific tools and structures that high net worth individuals can use to protect wealth in ways that are robust. This item, on the subject of what are called discounted gift trusts, is by Kim Jarvis, technical manager at the technical services team of Canada Life. As always, views of guest contributors aren’t necessarily shared by this publication, and readers are invited to respond. The editors are pleased to share such insights. Email tom.burroughes@wealthbriefing.com

A discounted gift trust allows a client to put a lump sum into trust for their chosen beneficiaries, while retaining the right to regular fixed payments. It uses the principle of carving-out the settlor’s entitlement to the regular fixed payments so that this part of the investment is not a gift for inheritance tax purposes. In effect it is an exchange of a lump sum for an income stream which ceases on death or when the fund is exhausted. 

When a trust wrapper is used with an investment bond the trustees, that the settlor appoints, become the legal owner of the bond.  The settlor is normally one of the trustees and can appoint any person as an additional trustee provided they are aged 18 or over and have full mental capacity. The trustees’ role is to manage the trust fund, meet the terms of the trust and act unanimously in any decisions they make; so it is important for the settlor to choose the trustees wisely.  

In this article we look at the trustees’ role under a discounted gift trust.

Duties during the settlor’s lifetime
On being appointed, a trustee should familiarise themselves with the terms of the trust as they need to comply strictly with the duties and directions as set out in the trust instrument (the trust deed). With a discounted gift trust the settlor must receive the regular fixed payments so the primary duty of the trustees, whilst the settlor is alive, is to pay the regular fixed payments every time the settlor survives to the date the entitlement arises. 

As these regular fixed payments must be paid the trustees must act prudently balancing risk and return across a portfolio of investments rather than looking at each investment in insolation.  When considering whether investments are suitable, the size of the investment must be considered as well as an appropriate balance between income and capital.  

Whilst managing the trust fund before exercising their powers of investment or reviewing the investments, trustees must obtain and consider proper advice as to how investments should be made or varied.  
The standard of care and skill expected of a trustee varies according to any special knowledge or experience that the trustee has or holds. In the case of a trustee acting in a professional capacity (for example a solicitor, accountant, stockbroker or professional adviser), the standard of care and skill should be appropriate to any special knowledge or experience that it is reasonable to expect of a person acting in the course of that kind of business or profession. The liability of individual trustees is limited so that they will not, generally, be held liable for any loss to the trust fund provided they act in good faith. Trustees who are paid for their services are also liable for their negligence.

The trustees must ensure that the regular fixed payments are paid to the settlor for the rest of their life or until the fund is exhausted.  Although it may be possible for the trustees to make an irrevocable appointment of benefits to another beneficiary within the trust, it is strongly recommended that such action is not taken because this could jeopardise the trustees’ obligation to make payments to the settlor.
Normally, under a discounted gift trust the trustees cannot fully surrender or take withdrawals during the settlors’ lifetime and this restriction will be included in the policy provisions or the trust deed.  However, providers will normally allow the trustees to take withdrawals to meet any ongoing adviser charges.  It is considered good practice for the ongoing adviser charge not to be linked to the fund value,  but to be a fixed monetary amount or a percentage of the original investment in order to reduce the possibility of a chargeable gain arising.  The trustees need to bear in mind that they have an obligation to make the regular fixed payments and reducing the value of the investment bond for other purposes could mean there is not enough money available to meet this obligation. 

Death of the lives assured
Where the underlying investment is a life assurance policy, if the last surviving life assured dies before the settlor the investment bond will end and the death benefit will be payable to the trustees.  
However, as the trustees will still have an obligation to make the regular fixed payments to the settlor they will need to reinvest the death benefit payable to them into an appropriate investment.  

Where the trustees reinvest the death benefit into a new investment bond they can exercise all the powers and options under the bond, including taking withdrawals. When the trustees are due to make the fixed regular payments to the settlor in accordance with their obligation, they have to make withdrawals or part surrenders. But the trustees must remember that the regular fixed payments cannot be changed and, as the 5% tax-deferred allowance will be based on the death benefit reinvested in the bond, which may be lower than the original investment, it may result in a chargeable gain arising.

Death of settlors
Where there are two settlors, for example a married couple or civil partners, on the first death the regular fixed payments must continue at the same level and are paid to the remaining settlor. On the surviving settlor’s death the right to receive the regular fixed payments will cease. The trustees then need to decide how to use the remaining trust fund for the settlor’s chosen beneficiaries.  

They can either continue the investment bond as an investment and distribute benefits as and when they feel appropriate, or cash in the whole investment and distribute the proceeds to the chosen beneficiaries.

The trustees have wide administrative powers to deal with the bond and to reinvest the proceeds in any way they wish. They also have power to borrow funds to make payments to parents or guardians of minor beneficiaries and to delegate certain powers.

Trustees have the power to advance capital from the trust fund and to make loans to the chosen beneficiaries; both of which can be very beneficial. In practice, this only takes place after the settlor’s death as they still need to meet the obligation of making regular payments. In particular, the power to lend may give rise to tax planning opportunities where, after the settlor’s death, their widow/widower requires funds from the trust but there is a desire to reduce the potential IHT liability on his or her subsequent death. In such a case, the trustees can make an encashment or withdrawal from the bond and make an interest-free loan, repayable on demand, to the widow/widower. Provided the loan is fully spent by the widow/widower, his or her taxable estate does not increase but, because the loan is repayable on death, it then effectively reduces the net estate of the borrower for IHT purposes. If the settlor’s surviving spouse needs cash after the settlor’s death, it may therefore be appropriate to consider a loan to him or her.
Under a discounted gift trust the trustee must ensure that:

-- The regular fixed payments are paid to the settlor for the rest of their life or until the fund is exhausted; 
-- None of the trust fund is passed to the chosen beneficiaries during the settlor‘s lifetime; 
-- If the last surviving life assured dies before the settlor, the death benefit is reinvested in order that the regular fixed payments can continue to be met, and

-- When the settlor dies, the regular payments will stop and the restrictions placed on the trustees, preventing them from cashing in the bond, no longer apply.

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