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Change in the valuation rate for discounted gift schemes

07/06/2023

There has been a recent change in the interest rate used by discounted gift schemes. This change may reduce the attractiveness of discounted gift schemes for inheritance tax planning. 

The interest rate used in discounted gift schemes is determined by HMRC. It was previously set in December 2013 at 4.5% per annum.

On 17 April 2023, HMRC published a new policy paper addressing this topic. This paper confirms that HMRC believe 4.5% is no longer an appropriate interest rate. Instead, from 1 May 2023, 6.75% must be used.

This change applies when valuing the retained rights in a discounted gift scheme both at inception and at any ten year anniversary that falls on or after 1 May 2023. 

What is a discounted gift scheme?

Discounted gift schemes are a popular tool used for inheritance tax planning. They are used to place a bond or policy into trust, with the settlor(s) retaining the right to receive a specified level of income for the remainder of their life/lives.

The value of the assets placed in trust is a transfer of value for inheritance tax purposes and will normally be classed as a chargeable lifetime transfer. However, the value of the amount transferred is reduced by the value of the income stream the settlor will receive in return. 

This means that the amount gifted into trust (moved outside the estate) is immediately reduced in value for inheritance tax purposes by the deemed value of the income stream (the retained rights). This can provide significant inheritance tax savings where the settlor making the gift dies within 7 years (or the gift would otherwise exceed the £325,000 nil rate threshold). 

A potential disadvantage of a discounted gift scheme is that although the estate will immediately reduce (by the value of the retained rights), it will later increase in value as the income is continually paid back to the settlor.

How the retained rights are valued

The value of the income stream (the discount) is calculated in a similar way as how a lifetime annuity is priced. As such, the value is largely based on two factors:

  1. The life expectancy of the settlor - how long the income is likely to be paid for, and,
  2. The interest rate – the return on similar income producing assets (such as gilts and bonds), plus an additional margin (the deemed rate of return an investor would require to purchase the income stream).

As interest rates have increased, the cost of purchasing fixed income stream assets (such as gilts, bonds and annuities) has reduced. In recognition of these changes, HMRC have increased the interest rate used for discounted gift schemes from 4.5% to 6.75% from 1 May 2023.

This change means that the deemed value of the income stream is reduced. As a result, anyone using a discounted gift scheme will get less of a discount on the amount placed in trust, creating a smaller inheritance tax saving. 

Comment 

Rapid changes to the interest rate environment are having a significant effect on financial planning. Rises to the Bank of England base rate has led to savers starting to be able to receive a return on cash savings, but have also made mortgages much less affordable. 

Correspondingly, higher interest rates have reduced the cost of securing guaranteed income in retirement (i.e. fixed and lifetime annuities). Unfortunately, they have now also reduced the inheritance tax saving when a discounted gift scheme is used.  

Important Information

Please note this is for general information only and is based on LV=’s understanding of the relevant legislation and regulations and may be subject to change.

The tax treatment of benefits depends on individual circumstances, and may be subject to change in the future.

The use of this document is at your own risk, and the content should not be used for the provision of professional advice.

LV= accept no liability for any damages, losses or causes of action of any nature arising from your use of this document.