Discounted gift trust underwriting
Many life assurance companies market the use of discounted gift trust as part of inheritance tax planning. But not all have the same approach to medical evidence and underwriting. This document explains how the value of the discount is calculated and sets out some of the different approaches to obtaining and using medical evidence.
Facts and analysis
What is the value of the discount?
Strictly, the value of the discount is the price the settlor's entitlement might reasonably be expected to fetch if sold in the open market i.e. what an open market purchaser would pay for the entitlement. This is set out in s160 Inheritance Tax Act 1984 (IHTA).
In practice, providers will produce a value based on the size of the settlor's entitlement and their life expectancy. That in turn is affected by age and state of health. Assumptions are also made as to likely investment returns and future interest rates (although most will now use the interest rate suggested by HM Revenue & Customs (HMRC).
HMRC’s view is that an open market purchaser will not buy the settlor's entitlement at all unless a whole of life insurance could be effected on the settlor's life at the time the trust is created. Thus, if the settlor is uninsurable for any reason at that time, a purchaser will not buy and the value of any discount is zero. (HMRC take the view that anyone aged 80 or over (including any medical loading) is uninsurable.) HMRC will then not allow a discount on the settlor's death within 7 years.
Underwriting the settlor's state of health
The approach to underwriting varies from provider to provider. Some carry out no underwriting at all, although sometimes this can be at the request of the customer. In many cases a discount "certificate" will only be provided where underwriting has taken place. Some, like Aviva, will underwrite provided a minimum investment amount is received. Our limit is £50,000. Some underwrite every case, but this is sometimes coupled with a relatively large minimum investment.
Discounted Gift Trusts and Underwriting
There are various approaches to underwriting in this market. This note is designed to give some background about the various processes in place. It is important to realise that a discount can still be allowed by HMRC regardless of the method chosen, although some may give rise to more uncertainties than others.
Underwriting in advance of the trust being created
The customer's state of health is ascertained before the trust is created. This means that the customer will get a good idea of the likely discount before the trust is created, and can take appropriate action e.g. decide whether to proceed with the trust or perhaps to delay creation of the trust where further medical information is required.
This is Aviva’s (and HMRC’s) recommended approach and is achieved by completing and submitting ‘Aviva’s Discounted Gift Trust – Assessment of life expectancy (underwriting form)’ before the trust or bond application is completed.
There is, of course, a possible issue where something happens to the health of the customer in the short time period between the medical evidence being obtained and the trust being created.
Underwriting after the trust is created
There are potential issues with this approach, which must be borne in mind so that any undesirable effects may be avoided.
On a practical point, the customer will have created the trust before his state of health is determined. He may be unhappy if he subsequently learns that he is uninsurable, which effectively means that HMRC will not allow a discount on death within 7 years. Had he known this in advance he might not have gone ahead with the trust. However, apart from the discount, the trust is still effective.
It is also possible that the customer is insurable at the time the medical evidence is examined, but would have been uninsurable on the date the trust was created.
For example, the customer may have undergone some medical tests shortly before creating the trust and the result of those tests was unknown on the day the trust was created. Subsequently, the results are obtained, the customer is given the "all clear" and the insurer’s underwriters conclude that the customer is insurable.
The stance that HMRC are likely to take is that on the day the trust was created (i.e. before the results were obtained) the underwriters would have deferred their decision until the test results were available. That means that the customer was uninsurable on the date the trust was created, and hence no discount would be allowed on death within 7 years
This may seem a harsh point of view, but that is our understanding of HMRC’s position. Our underwriters would need to look at the decision they would have made on the day the trust was created.
Where a customer is in that, or any similar situation, it would be best to await the result of any tests, or perhaps until a full recovery has been made from an operation, before creating the trust. This would help ensure that the underwriting decision given is the same as would have been given on the day the trust was created
Further information required
If, as part of the underwriting process, further tests are needed by the underwriter to determine life expectancy, no discount can be allowed. This is so even if the test results turn out to be OK. This is because test results were not available at the time the trust was created and without the results the underwriter is unable to offer life cover to the settlor.
The "sealed envelope" approach
This involves obtaining a GP Report at the time the trust is created, but not using it until it becomes necessary i.e. there is no underwriting decision and the evidence is only looked at if the customer dies within 7 years.
This has a similar issue with to “Underwriting after the trust is created" see above in that the trust is created without the customer being aware of insurability. Indeed, the customer is not made aware of insurability at all. It also precludes the possibility of further medical evidence being obtained e.g. a medical report.
Obtaining nothing in advance
Clearly, this also gives the problem of the customer not being made aware of insurability when the trust is created.
It also means that, on death within 7 years, HMRC will ask the executors to obtain medical evidence "in arrears", which may cause further distress at a difficult time for the family.
However, this procedure does not mean that a discount can never be allowed. If satisfactory evidence is obtained to demonstrate to HMRC that at the time the trust was created the settlor was insurable, they may well agree a discount.
Clearly, no discount will be given if the evidence eventually obtained indicates to HMRC that the settlor was uninsurable at the time the trust was created.
As can be seen, where underwriting, and thus the assessment of any discount is not conducted before the trust is created, the increased uncertainty of the availability of any ‘discount’ can significantly affect the inheritance tax planning being undertaken.
Thus, care is needed to ensure that this is taken into account and steps are taken to ensure that client’s looking to create this type of trust are fully briefed.
The information contained in this article has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2021. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice.