A Tax Tribunal case reported in October 2011 prompts me to review this popular method of “having your cake” and “eating it” – in this case making a lifetime gift to the children, perhaps while you are in your ‘70s to reduce IHT payable on death, whilst continuing to receive an income from the investments for life. HMRC have become quite aggressive about DGPs recently, winning cases which have reached the Tax Tribunal.

Prior to the early 2000s DGPs were being “sold” by insurance companies and Financial Advisers to the very elderly (above 90 years), in some cases without individual medical underwriting.

An actuary calculates the value of a right to receive the income for life, based on your health and life expectancy, as a percentage of the lump sum. The balance of the capital value passes via a trust to the children (or other beneficiaries) free of IHT if you survive for 7 years. A discount applies to the valuation of the children’s share, as they may have to wait 20 years before it falls into possession.

In recent years HMRC have made clear that they will not accept any “discount” on the value gifted if the person taking out the Plan was over 90 at the time. Furthermore, when death occurs (even if more than 7 years since the inception of the Plan) HMRC are likely to demand to see the medical history at the time DGPs were taken out, to make sure that medical underwriting was properly carried out.

In a case which comes to mind, a couple in their 80s took out two Plans in 2003 and 2005. Both died in 2010. The insurance company concerned did not require medical underwriting, simply using an actuarial calculation based on normal life expectancy for age. The actual medical condition of the couple in 2003 was poor to say the least – surviving for nearly 7 years was quite an achievement.

When reporting DGPs made within 7 and 5 years of the death respectively, the Executors found the original discounted gifts queried by HMRC. After reviewing all the medical records, the original discounts have been largely rejected and the cost to the Estate in its particular circumstances may be nearly £100,000 of extra IHT payable in respect of initial investments of £480,000.

If you know of family members or clients who took out DGPs prior to about 2005 it could be worth reviewing them as part of the family’s IHT strategy. Even if it is too late to do anything retrospectively, at least you may prepare yourself for a nasty shock, or have time to implement alternative IHT saving plans.

Stone King is not able to give specific advice on DGPs as regulated financial products, as we are not authorised by the Financial Services Authority, but we can review advice given to Plan holders in the light of recent Court cases, and suggest alternative methods of lifetime IHT planning where problems exist.