What Is a Discounted Gift Trust?
This article is for general information only and does not constitute personal financial, investment, tax or legal advice or a personal recommendation. Discounted gift trusts are long-term arrangements and may not be suitable for everyone. You will normally lose access to capital genuinely gifted into the trust. The value of the underlying investment can fall as well as rise. Tax treatment depends on individual circumstances and may change.
A discounted gift trust is an estate-planning arrangement that allows you to make a gift for your beneficiaries while retaining the right to predetermined payments during your lifetime. For Inheritance Tax purposes, the value treated as gifted may be lower than the amount originally invested because the rights you retain can have a value of their own.
A discounted gift trust may be one option to consider where you want to transfer wealth while retaining defined regular payments. Whether it is appropriate will depend on your individual circumstances, affordability, the trust structure, the underlying investment and the relevant tax rules. Gifted capital is normally no longer available to you, so affordability and future needs require careful consideration.
How does a discounted gift trust work?
A discounted gift trust, often shortened to DGT, usually combines an investment bond with a trust.
The basic process is:
- You invest a lump sum. The capital is usually placed into an investment bond.
- The investment is placed into a trust. The trust is established for your chosen beneficiary or beneficiaries.
- You retain predetermined rights. These normally provide regular capital payments during your lifetime.
- The remaining interest is gifted. The settlor is normally excluded from accessing the portion genuinely gifted into the trust.
- The trust ultimately benefits your beneficiaries. How and when they benefit depends partly on the type of trust selected.
The predetermined payments are normally withdrawals of capital rather than income generated by the trust. That distinction matters when considering both future cash flow and tax treatment.
Crucially, you retain these payment rights from the outset rather than giving them away and then continuing to benefit from them. That separation is central to how the structure operates.
HMRC's technical guidance on discounted gift schemes explains how retained rights are valued and why they need to be clearly defined.
For a broader explanation of trusts in estate planning, our guide to using trusts to mitigate Inheritance Tax covers the wider principles and considerations.
What does the “discount” actually mean?
The word discount can be misleading.
It is not a discount from an investment provider or a fixed tax allowance. Instead, it represents the value attributed to the payment rights you retain.
HMRC calculates the transfer of value according to the loss to your estate. Broadly, this means comparing the amount invested with the open-market value of the retained rights.
The amount originally invested is therefore not automatically the value of the gift for Inheritance Tax purposes. The retained rights must first be valued, and the resulting discount will depend on the circumstances at the date of transfer.
There is no standard discount that applies to everyone.
What affects the size of the discount?
Factors that can influence the valuation include:
- your age
- your state of health
- your insurability
- the level of payments retained
- mortality assumptions
- the terms of the arrangement
Health and insurability can be important because the value of retained rights depends partly on how long payments are expected to continue.
HMRC's guidance on discounted gift schemes and uninsurable lives explains that where someone was uninsurable when the arrangement began, the retained rights may have only nominal value. The amount treated as transferred may then be close to the amount originally invested.
The level of discount is not guaranteed. An illustration or estimated transfer value should not be treated as confirmation of the eventual Inheritance Tax treatment.
Bare or discretionary discounted gift trust?
A DGT may commonly be established using either a bare trust or a discretionary trust.
| Feature | Bare trust | Discretionary trust |
|---|---|---|
| Beneficiaries | Normally fixed from the outset | Trustees usually select from a defined group |
| Beneficiary entitlement | Beneficiaries have an absolute entitlement to their share | Trustees decide how and when beneficiaries benefit |
| Initial IHT treatment | Gifted portion generally treated as a potentially exempt transfer where the beneficiary is absolutely entitled | Generally a chargeable lifetime transfer. An immediate IHT liability may arise depending on the circumstances |
| Beneficiary flexibility | Limited | Greater |
| Relevant property charges | Generally outside the relevant property regime | Periodic and exit charges may apply |
With a bare trust, the beneficiary is normally fixed, so changing who ultimately receives the assets can be difficult.
A discretionary structure provides greater flexibility but can introduce additional tax and administrative considerations. HMRC's guidance on trusts and Inheritance Tax explains that relevant property trusts can potentially face charges when assets enter the trust, at ten-year anniversaries and when property leaves the trust.
The choice should reflect the intended beneficiaries, flexibility required and wider estate-planning objectives, not simply the potential tax outcome.
What are the potential benefits?
A DGT is designed around a specific trade-off: giving away capital while retaining defined rights to future payments.
Potential benefits can include:
- A potentially lower initial transfer value. The value of retained rights can reduce the amount treated as gifted for Inheritance Tax purposes.
- Predetermined lifetime payments. You retain specified rights rather than giving away the entire investment with no further benefit.
- Lifetime estate planning. The gifted element may potentially move outside your estate under the applicable Inheritance Tax rules.
- Investment performance. The underlying investment may rise or fall in value, affecting what remains within the arrangement.
- Beneficiary planning. A discretionary trust may allow trustees to respond to changing family circumstances.
These features need to be weighed against loss of access, investment risk, potential tax charges and administration.
Tax benefits are not guaranteed and should not be the sole reason for establishing a discounted gift trust.
What are the main risks and disadvantages?
The restrictions attached to a DGT make the initial decision difficult to reverse.
You normally cannot reclaim the gifted capital
Once assets have genuinely been given away, they are normally no longer available simply because your circumstances change. This is an important consideration before making a gift: you should consider whether you could still meet your future income and capital needs without the gifted assets.
Before considering a DGT, it is important to establish whether the proposed gift could affect your ability to fund retirement, later-life expenditure or unexpected costs.
Because the gift is normally irreversible, affordability should be considered before focusing on any potential tax benefit.
Your payments have limited flexibility
The level and pattern of retained payments are normally fixed when the arrangement is established.
You should not assume those payments can later be increased, reduced or reshaped to match changing expenditure. A DGT may therefore be less suitable where substantial access to capital could be needed later.
The underlying investment can fall in value
The investment bond remains exposed to investment risk. Its value can rise or fall, while withdrawals and charges can further reduce the fund.
Investment losses, charges and withdrawals can reduce the amount ultimately available within the trust for beneficiaries.
The 5% withdrawal rule is not a tax exemption
Investment bonds are often associated with a 5% withdrawal facility, but this should not be confused with tax-free income.
HMRC refers to this as the 5% deferral rule. Broadly, certain withdrawals of up to 5% of accumulated premiums can be made without an immediate chargeable-event gain, with any potential tax charge deferred until a later event.
Withdrawals from an investment bond can have tax consequences. The 5% rule is a tax-deferral mechanism rather than a guarantee of tax-free income.
Factors to consider when assessing a discounted gift trust
Factors commonly considered when assessing whether a DGT may be appropriate include:
- whether there is a potential Inheritance Tax exposure
- how much capital can genuinely be given away
- whether predetermined lifetime payments are required
- the availability of other income and capital
- the need for future access and flexibility
- age, health and insurability
- investment risk and charges
- whether simpler gifting could meet the same objective
A DGT should therefore be assessed against three questions: whether the gift is affordable, whether fixed retained payments provide enough flexibility, and whether the tax and investment structure is proportionate to the estate-planning objective.
These are considerations rather than eligibility criteria. Suitability depends on individual circumstances, the trust terms, the underlying investment and the relevant tax position.
Discounted gift trust vs making an outright gift
A DGT is more complex than simply giving assets away, so it is worth considering what that complexity achieves.
| Discounted gift trust | Outright gift |
|---|---|
| Predetermined payments can be retained | No continuing entitlement to the gifted capital |
| Retained rights may reduce the transfer value | Full amount is normally treated as gifted |
| Requires a trust and investment structure | Usually simpler |
| Access to gifted capital is restricted | Gift is given away completely |
| Investment and trust costs may apply | May involve fewer ongoing costs |
For smaller or more straightforward transfers, existing exemptions or outright lifetime gifts may be more appropriate. Our guide to gifts and Inheritance Tax planning explains some of the alternatives and why affordability matters before making significant gifts.
Is a discounted gift trust right for you?
A discounted gift trust should start with your financial plan, not with a target tax saving.
Before establishing a DGT, it is important to consider how much capital can genuinely be given away, likely future income and expenditure, who should benefit and how much flexibility may be needed.
It is also worth establishing whether simpler gifting arrangements could meet the same objectives without unnecessary complexity.
A DGT may be relevant where capital can genuinely be given away but predetermined lifetime payments are still required. Where future access to that capital could be necessary, another approach may be more appropriate.
If you are considering how gifting and trusts could fit into your wider plans, our Estate and Lifestyle Planning service can provide information about our approach to Inheritance Tax analysis, gifting strategies, trust-structure liaison and wider wealth-transfer planning. The appropriate approach will depend on your individual circumstances and may require financial, tax or legal advice.
Legal advice may be needed on the trust terms and their consequences. Where the arrangement involves an investment bond or other regulated investment, regulated financial advice may also be appropriate.
McCarthy Wealth is a trading style of Clarity Wealth Management LLP which is authorised and regulated by the Financial Conduct Authority. No: 575252
The Financial Conduct Authority does not regulate advice on estate planning, wills or probate. Tax and trust planning may also fall outside FCA regulation. Where an arrangement involves regulated investments, the associated investment advice may be regulated. This article is for general information only and does not constitute a personal recommendation. Tax treatment depends on individual circumstances and may change.
