Using Discounted Gift Trusts to reduce inheritance tax

Discounted Gift Trusts, often referred to as DGTs, are a way to reduce your potential inheritance tax bill while keeping access to a regular income.

In today’s article you’ll learn about how this type of trust works for those seeking to reduce the level of taxes levied on their estate when they pass.

Of course, it’s important to note, this article is for educational purposes and doesn’t constitute advice. Inheritance tax is a complex issue and each individuals situation is unique. Seek professional guidance before making any decisions.

What is a Discounted Gift Trust & how do they work?

You make a gift into a trust, but the part used to provide your income is ‘discounted’ for inheritance tax purposes.

The rest is treated as a gift and may fall out of your estate after seven years. These trusts are often used by those in good health who want to pass wealth on but still need an income.

Using a Discounted Gift Trust to mitigate inheritance tax

Many people want to pass money on to their children, but are unsure whether they’ll need it later in life.

A Discounted Gift Trust offers a middle ground.

You can take regular withdrawals from the trust, while potentially cutting your estate’s inheritance tax position.

Here’s how they work in practice:

• You transfer a lump sum into a trust set up by an IHT planner.
• You retain the right to receive a fixed annual amount from the trust for life.
• The leftover value could be a gift and may be outside your estate after seven years.
• HMRC applies a discount to your gift, based on your age and health
• This could reduce the inheritance tax impact straight away
• The discounted amount is never counted as part of your estate again.

This approach appeals to people with significant savings or investments who want to gift money but aren’t ready to give up access completely.

The level of ‘discount’ is calculated by the insurance company based on life expectancy.

If you’re brand new to this topic and prefer a shorter introduction first, we’ve created a quick read that covers the basics. Take a look at our short-form article covering the frequently asked question: What is a Discounted Gift Trust?

Example

Priya, aged 66, had £300,000 in her savings accounts. In a nutshell, he wanted to pass on these assets to her children. She placed these assets into a Discounted Gift Trust and chose to receive £12,000 a year.

The income gave her peace of mind. Additionally, the discounted value meant part of her estate was no longer included in her inheritance tax position straight away.

Why the discount matters

The name can be misleading; you’re not getting a discount in the retail sense. It’s a notional value based on how much income you’re expected to draw before death. That sum is considered to still be yours and remains outside the gift calculation.

The practical outcome?

• A lower initial gift value for inheritance tax purposes
• A faster reduction of your estate’s taxable value

In effect, the discount protects a portion of the gift from inheritance tax immediately. This is why DGTs are particularly suitable for those in good health, as a higher life expectancy leads to a larger discount.

Example

Jean-Claude, a gentleman in his 50s set up a Discounted Gift Trust with £200,000. Based on his age and current level of health, the insurance company applied a £60,000 discount.

That portion was excluded from his estate immediately. Lastly, the remaining £140,000 may fall outside his estate after seven years, assuming he lives that long.

Using offshore bonds with Discounted Gift Trusts

Offshore investment bonds are a popular funding method for this type of trust. 

They allow the underlying investment to grow tax-deferred while providing a steady income stream. If you’re exploring tax-efficient IHT planning strategies, take a look at our guide to Offshore Investment Bonds.

What kind of income can you take from a Discounted Gift Trust?

You can choose the amount you want to receive each year when you set up the trust, within limits. This income is technically a return of your original capital, not interest or growth.

Some important points to know:

• You can’t change the amount once the trust is in place – be clear on this
• The income isn’t taxable as it’s treated as capital being returned
• If the investments underperform, the capital can run down faster than expected

In short, this is a steady drip of your own money coming back to you. You’re not taxed on it, but nor are you drawing from future growth.

Example

Zoe chose to withdraw £8,000 a year from her Discounted Gift Trust. Because this was treated as a return of her original capital, she didn’t pay income tax and didn’t need to report it to HMRC. Moreover, she used the payments to top up her other pension income each year.

What happens to the money after you pass away?

When you die, the trust continues, and the remaining assets pass to your chosen beneficiaries outside of your estate, assuming the seven-year rule has passed for the gift portion.

Here’s what happens next:

• Your right to the income ends at death
• The remaining trust assets go to the beneficiaries

To summarise, if death occurs within seven years, some or all of the gift may still be subject to inheritance tax

It’s worth noting that if you die within seven years of setting up the trust, only the non-discounted portion of the gift may be taxable.

The rest (the ‘discount’) is not included. All in all, these details are well worth noting.

Example

Arjun died six years after setting up his Discounted Gift Trust. The £75,000 discounted portion stayed outside his estate. The remaining gift was still included, though his estate qualified for taper relief.

His daughter received the trust proceeds without needing probate, as the trust continued without interruption.

When a Discounted Gift Trust may be a good IHT reduction solution

These trusts aren’t for everyone, but they can be a useful part of inheritance tax planning if:

• You’re in good health and want to reduce your estate now
• You have enough other income to live on, with the DGT acting as a top-up
• You want to maintain access to some capital, but pass the rest on tax-efficiently
• You’re comfortable giving up access to the remaining capital (you can’t dip back in)

For those who meet the criteria, the benefits can be significant. But the structure is rigid, so it needs to be planned properly with professional advice.

Example

Taylor had no children but wanted to support their niece. They used a DGT to pass on £100,000 while keeping an annual income of £4,000. The trust structure gave them control during their lifetime and helped reduce inheritance tax exposure over time, assuming their health stayed stable.

Potential drawbacks & key considerations with Discounted Gift Trusts

Some people are drawn to the inheritance tax savings without fully understanding the long-term consequences. Here are a few things to watch for:

• You can’t change your mind once the trust is set up
• There’s no access to the capital beyond the agreed income
• If your circumstances change, the trust won’t adapt
• It may affect your ability to claim certain benefits or allowances

This isn’t a flexible product; it’s designed for a specific purpose. If that purpose no longer fits, you could be locked into something that doesn’t work for you.

Looking at other trust options?

This article has focused on how DGTs help reduce inheritance tax while allowing a fixed income. But they’re not the only trust structure worth considering:

• Loan Trusts allow  full access to capital, while the growth falls outside your estate
• Flexible Reversionary Trusts allow optional withdrawals and staged wealth transfer
• Some trusts suit cautious planning, others offer more control and other benefits

To explore all three in one place, read our guide on the different types of trusts for inheritance tax planning, and see which might suit your long-term goals.

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