Heads, tails or the tax dog?

This year’s Finance Act has certainly sparked a lot of debate. The tax and trust sessions that have been run at our regional seminars and other industry forums have been packed to the rafters as advisers try to get their head round the new rules and how they should be advising their clients.

However, whilst the debate still lingers, we are starting to see some real action as the industry begins to launch new products that are in line with the Finance Act.

We have launched our new discounted gift trust, with both bare and discretionary versions but we are not alone. Many providers have launched new products and you now have to determine which are most appropriate for your clients in the new regime. It’s not all that easy, especially if your business commitments have not permitted you to attend educational seminars on the subject or follow the debates in the press.

There is such a range of options available and what makes the right choice for any one client is not necessarily obvious. The client relies on you to guide them to the best fit, depending on their individual needs. For some, flexibility is important, even at the cost of new tax charges. For others, it is appropriate to forego that flexibility and tax may be saved.

You will be familiar with the IHT benefits of DGTs but in the new world it is important to consider carefully whether you opt for a DGT with a bare or discretionary trust underpinning it.

The key benefit of a bare version is that the gift is treated as a potentially exempt transfer (PET) and therefore avoids the recent changes to trusts and inheritance tax introduced by the Finance Act. If selecting this option, the client must name specific individuals at outset which cannot be changed and there will be no IHT liability as long as they live for seven years after making the gift. Care should be taken where the beneficiaries are minors.

For clients who require more flexibility, a discretionary trust allows them to nominate a particular class of individuals, such as “all my children, born and unborn”, and the trustees have the flexibility to add to the class in the future. As the gift is treated for tax purposes as a chargeable lifetime transfer (CLT), it is subject to entry, exit and periodic charges, in line with the IHT treatment of gifts into trust since Budget day 2006.

However, if the discounted value of the gift is less than the nil-rate band, no entry charge will arise and there may possibly never be any actual tax to pay at the 10-year point or on exits. In this case, a bare version would not be appropriate given the unnecessary price paid in terms of loss of flexibility.

As ever though, the tax tail must not wag the investment dog. When recommending DGTs it is imperative that you select a product that has sufficient investment flexibility in the underlying bond to meet your clients’ individual investment needs.

The key point is that not all clients are the same. A trust that is entirely appropriate for one family may well be entirely wrong for another, which demonstrates precisely why those families need your advice.

Colin Jelley is head of tax and financial planning at Skandia

The views expressed are those of the author and not those of the company he represents.