Discounted Gift Trusts: How They Work and When to Use Them

One of the central tensions in inheritance tax planning is the conflict between wanting to pass on wealth and needing to retain enough income to live on. Many straightforward IHT planning tools — outright gifts, trusts, Business Property Relief investments — require either giving up the money entirely or accepting significant complexity or risk. The Discounted Gift Trust (DGT) occupies a useful middle ground: it allows an individual to make a substantial gift while retaining a regular income stream, and achieves an immediate partial reduction in the IHT estate rather than waiting the full seven years for a gift to fall out of the estate entirely.

What Is a Discounted Gift Trust?

A Discounted Gift Trust is a type of trust, usually wrapped around an investment bond (typically an offshore or onshore insurance bond), into which the settlor makes a lump sum gift. The structure allows the settlor to:

1. Retain a regular income stream (technically, the right to regular cash withdrawals from the bond) for life or for a fixed term
2. Make an immediate gift of the remainder of the trust to beneficiaries
3. Achieve an immediate IHT discount on the value of the gift, because the value of the settlor's retained rights is deducted from the value that is treated as a gift for IHT purposes

The word "discounted" refers to this immediate reduction: the full investment amount does not count as a gift for IHT purposes immediately — only the "discounted" amount (the capital value after deducting the retained income stream) is transferred.

How the Discount Works

The discount reflects the present value of the income stream the settlor retains. Actuarial calculations take into account:

• The amount of the regular withdrawal
• The settlor's age and life expectancy
• The assumed investment growth rate

Example (illustrative): A 70-year-old invests £500,000 in a DGT and retains a 5% per annum withdrawal (£25,000/year) for life. Actuarial calculations might value the retained right to income at £150,000. The gift to the trust is therefore treated as £350,000 (not £500,000) for IHT purposes from day one.

This £350,000 is a chargeable transfer — if the trust is a discretionary trust (the most common structure), it enters the discretionary trust regime and is subject to the periodic and exit charges that apply to discretionary trusts. If the settlor survives seven years, the original discounted gift falls out of their cumulative total.

The immediate saving is the 40% IHT on the discount — in the example above, £60,000 (40% × £150,000) is saved compared to retaining the full £500,000.

The Retained Income Stream

The income retained from a DGT is technically a withdrawal from the insurance bond. Under UK tax rules, withdrawals from a bond of up to 5% of the original premium per year are treated as deferred income — no immediate income tax charge. This makes DGTs particularly efficient when combined with the 5% withdrawal allowance.

If withdrawals exceed the 5% allowance (in aggregate across the life of the bond), a chargeable event gain may arise, taxable as income.

Withdrawals are made to the settlor personally — they are not part of the trust fund and do not affect the trust's IHT position.

Critically: the income stream cannot be varied or stopped easily once set. The settlor's right to income is fixed at outset and cannot be increased (doing so would cause the arrangement to fail for IHT purposes). If the settlor's financial needs change materially, this inflexibility can be a disadvantage.

Tax Treatment

IHT. The discounted element is immediately removed from the IHT estate. The undiscounted amount transferred to the trust is:

• A potentially exempt transfer (PET) if the trust is a bare trust
• A chargeable lifetime transfer (CLT) if the trust is discretionary — subject to 20% IHT at outset if it exceeds the nil-rate band (currently £325,000 after considering any prior CLTs in the previous seven years)

Periodic charges (every ten years) and exit charges apply to discretionary DGTs.

Income tax. Within the investment bond, investment returns accumulate free of income and capital gains tax. Withdrawals within the 5% allowance are deferred, not free — any cumulative gain in the bond is taxable as income when the bond is assigned or surrendered.

Capital gains tax. No CGT within the bond wrapper.

Who Is a DGT Appropriate For?

DGTs are most appropriate where:

• The individual has surplus capital that exceeds their long-term income needs
• They are older (the discount is larger for older investors due to shorter life expectancy and therefore a lower present value of retained income)
• They wish to make a gift but are not willing or able to give up access to a regular income stream
• The immediate IHT discount is important to them (unlike a straightforward gift into trust, where the full value counts as a CLT from day one)
• They are willing to accept the inflexibility of a fixed income stream

DGTs are less appropriate where:

• The individual's income needs may change significantly (the retained withdrawal cannot be varied upwards)
• The individual is in poor health (the discount will be small if life expectancy is short, and HMRC may challenge the discount calculation if there is evidence of pre-existing serious illness)
• The individual is relatively young (the discount is smaller, reducing the efficiency of the structure)

HMRC's Position

HMRC accepts DGTs as a legitimate IHT planning structure but scrutinises the discount calculation. Key points:

• The discount must be calculated using reasonable actuarial assumptions
• HMRC may challenge the discount if the settlor was in poor health at the time of settlement and their actual life expectancy was materially shorter than the actuarial tables assumed
• Provider actuarial calculations should be obtained before settlement and retained as evidence

The structure has been in use for many years and is well-established — it is not an aggressive or artificial tax avoidance scheme. It works within the principles of IHT law.

Alternatives to Consider

DGTs should be considered alongside other IHT planning tools:

• Outright gifts (seven-year clock starts immediately; no retained income)
• Gift and Loan trusts (lender retains a loan account rather than a right to income — greater flexibility but IHT saving is different)
• Business Property Relief investments (BPR-qualifying assets held for two years can attract relief, but from 6 April 2026 100% relief is capped at £2.5m per individual — transferable between spouses — with only 50% relief above that, and AIM/unlisted shares now qualify for 50% relief only; liquid, no retained income needed)
• Whole of life insurance (pays a lump sum on death to cover the IHT liability; no reduction in estate but funds the IHT bill)
• Regular gifting from income (gifts from normal expenditure out of income are immediately IHT-free; requires surplus income)

The right combination depends on the individual's financial position, health, and objectives.

Practical Steps

1. Quantify the IHT liability and identify assets available for planning
2. Assess whether a fixed income stream from the DGT is genuinely affordable (do not invest money you will need access to)
3. Obtain actuarial discount calculations from the product provider
4. Ensure independent financial advice is taken — DGT suitability is highly individual
5. Review the arrangement periodically: if the settlor's health deteriorates materially, the actuarial assumptions may need revisiting

How Global Investments Can Help

At Global Investments, we advise HNW clients on IHT mitigation strategies including Discounted Gift Trusts, BPR investments, regular gifts from income, and trust structures. We can assess whether a DGT is appropriate for your circumstances, obtain quotes and actuarial illustrations from leading providers, and coordinate the advice with your legal team on trust documentation. If you are internationally mobile, we can also advise on how a DGT interacts with your broader cross-border estate plan.

This article is for general information only. IHT planning is highly individual and rules may change. The value of tax reliefs depends on individual circumstances. Investments can fall as well as rise in value. Always seek qualified professional advice before proceeding with any IHT planning.