A brief overview of Discounted Gift Trusts

A DGT generally combines an investment bond with either an absolute or discretionary trust.  Some providers may also offer a flexible (interest in possession) trust.

Under the terms of the trust, the settlor retains a right to fixed payments during their lifetime, referred to as ‘income’, but satisfied by withdrawals from the investment bond during their lifetime.  

The settlors retained right is actuarially calculated based on a method accepted by HMRC and reflects their age and state of health. If eligible, the settlor will be provided with a ‘discount’ which in effect is the capitalised value of the income they select, based on prevailing interest rates and their life expectancy. This ‘discount’ provides an immediate reduction in their estate for IHT purposes. If the settlor is 90 or above or in poor health an alternative option may be more appropriate.  

The IHT treatment of the trust will depend on whether an absolute trust is used or a discretionary trust. If the trust is absolute, the amount settled less any discount will be a potentially exempt transfer (PET) or if a discretionary trust is used, then the amount settled less any discount will be a chargeable lifetime transfer (CLT).   

Provided the settlor survives seven years, the transfer (i.e. the gift less any discount) will generally fall out of account however, if the gift fails, it will use part/all of the settlors’ available nil rate band. If the gifted amount is more than the available nil rate band, taper relief may apply to reduce any IHT payable. 

If a discretionary trust is used it will not form part of any beneficiary’s estate. The trust will be subject to discretionary trust taxation, although no exit charges will arise in respect of making the fixed payments to the settlor during their lifetime.  

The main use of this plan is  therefore to provide a fixed ‘income’ for life, or until the trust fund has been exhausted while also benefitting from an immediate IHT reduction, where eligible.

Example:

Bill, a 72 year old widower has £480,000 he wishes to invest to provide him with regular ‘income,’ while also wishing to reduce his estate for IHT purposes.

After medical underwriting has taken place, he is awarded a ‘discount’ of £165,000.

He has not made any other gifts, however, does use his annual £3,000 IHT exemption. He decides to set up a discretionary DGT combined with an onshore investment bond.

The £165,000 ‘discount’ benefits from an immediate IHT saving of £66,000.

The gift (CLT) of £315,000 is within his available nil rate band so there is no lifetime IHT to pay. Provided he survives seven years, the further potential IHT saving would be £126,000 – so £192,000 in total. In addition, he continues to enjoy an annual ‘income’ of £24,000 per annum (£480,000 x 5%) from the investment bond throughout his lifetime or until exhaustion of the fund.

Upon Bill’s death the trustees can administer the trust in accordance with its terms. Ideally upon creation of the trust, Bill should have written a letter of wishes setting out who he would like to benefit upon his death.

This just provides one option when it comes to estate planning and as mentioned, will appeal to those who wish to mitigate IHT while having continued access under the terms of the trust. In practice deciding on what may/may not be suitable will depend on the clients’ overall circumstances and objectives.

Note it has been confirmed that the Autumn Budget will take place on 26 November 2025. It is expected to include changes to IHT, with rumours suggesting a lifetime cap on gifts made before death and also discussions around the tightening of taper relief. It will be interesting to see what happens but if these changes do go ahead this could have a significant impact for those wishing to carry out estate planning in the future.