We will explain what a discounted gift trust is and why many people choose this route in estate planning.
At its core, a DGT can reduce the value treated as a transfer into a trust because the settlor keeps a preset stream of capital payments.
This can mean an immediate fall in your taxable estate, but it brings long‑term limits on capital access and control.
We’ll guide you through who suits this approach, what can go wrong, and the key questions to ask before you sign any documents.
HMRC may review the discount after death, so correct setup and clear records matter as much as the product choice.
We’ll keep jargon low and facts high. If you want a focused primer, see our guide on trusts and estate protection.
Key Takeaways
- Offers a potential immediate reduction to your taxable estate through a discount.
- Settlor keeps fixed payments while capital sits outside the estate for IHT purposes.
- Long‑term inflexibility is the main trade‑off to weigh up.
- HMRC can question the discount after death; records and structure matter.
- Often funded with an investment bond; tax results depend on withdrawals and chargeable events.
What a discounted gift trust is and why it’s used in inheritance tax planning
The structure separates the amount you retain as payments from the value passed to beneficiaries. This split matters in estate work. It lets someone keep a steady capital payment stream while the remainder sits outside their estate.
How it differs from a traditional gift trust
With a traditional gift trust you normally give up access to capital. Take money back and the arrangement may be treated as a gift with reservation. By contrast, a discounted gift trust gives a contractual right to fixed payments for life. That right is set at the outset and shapes the discount and future flexibility.
The two “pots” explained
- Retained payments: the predictable income you keep.
- Discounted gift: the residual fund for beneficiaries after the retained amount is valued.
“The discount reflects what has been kept back, not what you have given away in full.”
| Feature | Traditional gift trust | Discounted gift trust |
|---|---|---|
| Access to capital | Usually lost | Retained via fixed payments |
| Immediate estate reduction | Yes if truly relinquished | Yes, by the calculated discounted amount |
| Flexibility later | Limited | Restricted by payment terms |
We find many homeowners and other individuals use this tool for practical planning purposes. It blends lifestyle protection with estate reduction in a single, documented arrangement.
How using a discounted gift trust for inheritance tax uk can reduce your taxable estate
We explain how the split between retained payments and the remaining fund works in practice and why that split matters on day one.
Immediate IHT impact of the discount
A portion of the transfer can be treated as immediately outside the estate, lowering what counts for IHT from day one. This discount reduces the value treated as transferred and so cuts the initial IHT exposure.
What falls outside your estate straight away
The discounted element itself sits outside the estate at once. Any investment growth inside the fund also sits outside for IHT purposes.
“The discount can give an instant estate saving, but you must understand which part still follows the seven‑year rules.”
How the seven-year rule applies to the non-discounted portion
The balance that isn’t covered by the discount is treated as a gift. If the settlor dies within seven years, that portion may remain in the taxable estate. Surviving seven years usually removes this part from IHT.
| Element | IHT treatment immediately | After seven years |
|---|---|---|
| Discounted portion | Outside estate | Remains outside |
| Non-discounted portion | Within estate (potentially) | Cleared from IHT if seven years passed |
| Investment growth in fund | Outside estate | Remains outside |
We recommend reading our detailed guide on protecting your family’s assets to link these mechanics into wider planning choices.
How a discounted gift trust works in practice
Most advisers start by placing a lump sum into an investment bond, then moving that bond into trust. An onshore or offshore bond is common. This keeps record-keeping tidy and supports investment growth while withdrawals stay tax-deferred.
Funding with an onshore or offshore investment bond
The bond holds the fund. Trustees control the bond and make agreed payments to the settlor for life. Bonds suit medium‑to‑long term investing and simple administration.
Fixed capital payments and why they are capital, not income
Trustee payments are generally treated as capital distributions, not income. That changes how recipients budget and how tax on withdrawals is assessed.
Why the payment stream can’t be changed once set
Once you choose the payment level and frequency, you cannot increase them later. This locks in access and is a key planning trade‑off.
The 5% annual withdrawal allowance and what it means
Most bonds allow up to 5% per year of the original investment to be taken without an immediate income charge. Exceeding that can trigger chargeable events and unexpected tax bills.
| Feature | Typical outcome | Planning note |
|---|---|---|
| Bond type | Onshore or offshore | Choose based on domicile and reporting needs |
| Payments | Fixed for life | Set conservatively to match spending |
| Withdrawals | Up to 5% pa allowance | Keep records; avoid excess withdrawals |
“Match withdrawal levels to likely lifetime spending and inflation before you commit.”
Types of discounted gift trusts and which structure fits your goals
Which DGT you pick affects beneficiaries’ rights, trustee powers and long‑term charges. The main choice is between an absolute model and a discretionary model. Each route changes how the arrangement is taxed and who controls assets later.
Absolute (bare) option and when it fits family planning
An absolute trust gives fixed entitlements to named beneficiaries. That makes outcomes clear. It typically creates a PET outcome and suits parents who want capital to pass directly to children or grandchildren.
Discretionary option and the flexibility trade-off
A discretionary trust lets trustees pick beneficiaries from a named class. That brings flexibility when family needs may change.
But, this structure usually enters the relevant property regime and can trigger periodic and exit charges. Flexibility comes with tax complexity.
Joint‑life and single‑life designs
Couples often choose joint‑life versions so payments continue until the second death. Single‑life options suit individuals who want a simpler, single‑lifetime plan.
“Structure is not paperwork — it decides tax treatment, control and who benefits.”
- Fit guide: absolute trust for certainty; discretionary trust for flexibility.
- Practical point: many settlors act as trustees to keep oversight while maintaining a valid transfer.
- Trade‑off: more flexibility usually means more long‑term charges and admin.
How the discount is calculated and when it can be nil
We explain the maths and medical checks that turn an advertised discount into a defensible figure.
How providers work it out. The discount is an actuarial valuation of the right to your future payments. Underwriting estimates your likely remaining life. Expected lifetime payments are then converted to present value using a discount factor and reduced for costs.
The settlor’s age and health drive the life assumption. Better health or a younger age lengthens expected life and lowers the discounted value of the transferred pot. Poorer health shortens assumed life and raises the discount.
Payment level matters. Higher fixed payments increase the value you retain. That usually raises the discount because more of the original premium is treated as kept rather than given away.
Be warned: where someone is, or is rated, over 90 the discount may be nil or negligible. In that case the amount treated as transferred can approach the full premium paid.
HMRC review risk. HMRC can examine the discount after death and adjust it if underwriting assumptions prove optimistic. That creates uncertainty for beneficiaries.
Buyer’s checklist. Ask the adviser/provider about the life tables used, medical evidence required, how payments affect the discount level, and what happens if HMRC disputes the calculation.
Inheritance tax treatment: PETs, CLTs and relevant property charges
Different legal forms feed into very different inheritance tax rules. We explain the three main routes and what they mean for trustees and beneficiaries.
PET rules for bare/absolute structures
With a bare or absolute arrangement, the transfer usually counts as a potentially exempt transfer (PET).
If the settlor survives seven years the gift falls outside the estate. If death occurs within seven years the value may be brought back in and taxed. We advise tracking the seven years carefully.
CLT entry charge and the nil-rate band
Discretionary arrangements typically create a chargeable lifetime transfer (CLT). That can trigger an entry charge if the transfer exceeds the nil-rate band (commonly referenced at £325,000).
Early CLTs reduce the remaining nil-rate band available later. This affects the rate applied on future transfers.
Periodic ten-year charges and exit charges
Discretionary structures sit in the relevant property regime. That brings a periodic ten-year charge and possible exit charges when capital leaves the arrangement.
These charges are assessed at rates set by law and depend on the value held and time elapsed since the last charge.
Taper relief timings and what it does (and does not) change
Taper relief can reduce the tax rate payable on gifts if death occurs between three and seven years after a transfer.
Importantly, taper relief does not alter the value of the gift — it only reduces the tax due. Records must show dates clearly to claim relief.
“Choose structure with care. The initial decision shapes rates, records and long‑term duties for trustees.”
| Situation | Treatment | Practical note |
|---|---|---|
| Bare/absolute | PET — seven years | Keep survival evidence; beneficiaries get clear title |
| Discretionary | CLT entry charge; periodic ten‑year and exit charges | Requires ongoing monitoring by trustees |
| Death 3–7 years later | Taper relief may reduce tax rate | Value transferred remains unchanged |
- Remember: discretionary forms need regular reviews and tight record-keeping.
- Practical tip: seek professional tax planning advice before any transfer. Errors can be costly and hard to unwind.
Income tax and chargeable event gains you need to understand
We outline when an investment bond can create a chargeable event gain and who may meet the bill.
What counts as a chargeable event gain
A chargeable event gain arises when growth inside a bond is realised. Common triggers include full surrender, maturity, the last life assured dying, or withdrawals above the 5% annual allowance.
Who pays in absolute structures
In bare or absolute trust setups, assessment can vary. During life, excess withdrawals are usually charged to the donor or settlor.
After death, beneficiaries may be assessed in some cases. HMRC applies a just and reasonable basis where rights and timing make outcomes unclear.
Who pays in discretionary arrangements
While the settlor is alive and resident, gains often rest with them. After death, UK trustees typically become liable to account for any chargeable event gain.
Emergency advancements and practical checks
Making an advancement without reducing the settlor’s rights can shift the assessment point. That can turn what seemed like an intra‑family payment into a taxable event on trustees or beneficiaries.
“Stress‑test withdrawals and late‑life encashments. Small actions can change who is assessed.”
| Event | Typical assessor | Usual outcome |
|---|---|---|
| Full surrender | Settlor while alive; trustees after death | Chargeable event gain crystallised; income reported |
| Part surrender above 5% allowance | Settlor (excess) or beneficiary post‑death | Taxable gain pro‑rated on growth element |
| Death of last life assured | UK trustees or beneficiaries depending on structure | Gain treated as realised; returns required |
| Emergency advancement | May transfer liability to trustees or beneficiaries | Assessment depends on whether settlor’s rights were reduced |
Buyer guidance: run scenarios against likely withdrawals, care costs and surprise encashments. Look at bond taxation notes on investment bond taxation and check wider estate planning tips at secure your family’s future.
HMRC’s stance, reservation of benefit and pre-owned asset tax
Official guidance accepts the basic model, yet makes clear that valuation and evidence must stand up to inspection.
How HMRC frames the model
HMRC’s Inheritance Tax Manual sets out how the arrangement should work in practice. It recognises the mechanics and the way value splits between retained payments and the transferred fund.
What “works as described” really means
The phrase means the form is accepted in principle. But HMRC can still question the calculations or the medical underwriting after death.
“Paperwork must match practice: clear records and robust valuation matter most.”
Reservation of benefit and why most plans avoid it
The settlor does not reclaim the payment right. That right is carved out at the start. So the usual rule that voids a gift with reservation of benefit rarely applies.
POAT considerations
Pre-owned asset tax targets arrangements that leave someone in effective use of an asset. A properly run arrangement should not normally trigger POAT. The test is practical: did the settlor retain use of capital or simply receive fixed payments?
- Keep it clean: separate personal spending from trustee decisions.
- Check documentation: ask your adviser what evidence supports the valuation and how HMRC would view the plan after death.
Pros, cons and risks to weigh before you buy
Deciding whether this approach suits your plans means weighing clear benefits against real limitations.
Key advantages
Immediate IHT benefit: the discount can reduce what counts in your estate right away.
Lifetime access: preset payments give predictable cash flow while capital sits in trust.
Asset protection: moving funds into trusteeship can shelter growth from later estate charges.
Key drawbacks
Inflexibility: payment levels are fixed and cannot be increased later.
Capped withdrawals: many bonds limit tax‑free withdrawals to protect the overall structure.
Loss of control over capital: the underlying fund is no longer yours to reclaim.
The risk of an unexpected HMRC outcome
HMRC may reassess the discount after death. That can raise IHT bills compared with illustrations.
We always stress stress‑testing discount assumptions and keeping robust medical and valuation records.
Common planning pitfalls
Reinvesting retained payments can rebuild the very estate you aimed to shrink. That undoing is common and costly.
Acting as trustee gives oversight, but it does not restore capital ownership. That control versus comfort trade‑off must be clear.
“Match likely withdrawals to long‑term spending. Small choices now can change future tax and estate outcomes.”
- Check modelled IHT projections and worst‑case HMRC scenarios.
- Confirm withdrawal rules and the 5% practical limit on the bond.
- Ask for valuation tables, underwriting notes and a written stress test.
- Read our practical tips in this short guide: six legal ways to reduce IHT.
Costs, administration and compliance for UK trusts
Good administration turns an estate-planning product into a reliable legacy, not a future problem.
We explain the ongoing duties that follow any DGT and why steady oversight matters.
Trust Registration Service and updates
UK-resident or taxable trust registration must happen within 90 days. Trustees must update the TRS when key details change.
Certain records also need refreshing at ten-year points. Missing these updates risks penalties and extra enquiries.
IHT100 reporting and what trustees must monitor
Trustees should watch the trust’s value each year.
If the fund exceeds 80% of the nil-rate band at a ten-year anniversary, an IHT100 return may be required even if no tax is due.
Costs and practical expectations
Expect adviser fees, trustee administration charges and product costs inside the bond.
Being a trustee is manageable. It is not a set-and-forget plan.
“Good records reduce mistakes, penalties and family stress.”
- Keep: beneficiary lists, bond events and payment history.
- Review: values, IHT dates and reporting deadlines every year.
A worked example: what a discounted gift trust could achieve for a UK family
To make the numbers real, we’ll run through a clear household scenario with figures you can follow.
Illustration using a lump sum, fixed withdrawals and a stated discount
A couple places a lump sum of £500,000 into the plan and opts for fixed payments of 3% (£15,000 each year).
An actuarial discount of 40% means £200,000 is immediately treated as outside their estate. The remaining amount, £300,000, is subject to the seven years rule.
Comparing IHT exposure at outset, within seven years and after seven years
- At set‑up: taxable estate reduces by the discount (£200,000).
- Death within seven years: the £300,000 may be brought back into the estate and could face IHT at typical rates (up to 40%).
- Survive seven years: the £300,000 normally falls outside estate charge and investment growth inside the fund also sits outside.
Reality check: this example is illustrative. Actual outcomes depend on underwriting, age, health and exact payments. We recommend personalised modelling before you commit.
Conclusion
The plan turns one premium into two outcomes: steady lifetime payouts and a residuary fund for beneficiaries.
We see this as a clear split between the settlor’s right to regular payments and the remainder that can reduce estate exposure. The model can deliver an immediate saving in tax while preserving predictable access to cash.
But it is not simple. The arrangement is relatively inflexible, discounts can be negligible at advanced ages, and HMRC may review outcomes after death. Choice of structure — bare or discretionary — changes duties, charges and who pays.
Before you proceed, keep records, stress‑test withdrawals and ask for written scenarios. For a technical overview, read our technical guide.