Discounted gift trusts; are they the silver bullet the papers made them sound like?

If you’ve read the recent coverage on discounted gift trusts and wondered whether you should be setting one up, here’s the short answer: they can be genuinely useful tool for inheritance tax planning, but they’re not a silver bullet, and whether one suits you depends entirely on your own circumstances. Let me explain what they are, when I’d actually consider one for a client, and where they fall short.

What is a discounted gift trust?

Strip away the jargon and a discounted gift trust (DGT) does something fairly simple: it lets you gift a lump sum out of your estate for inheritance tax purposes, while carving out the right to a regular income from that same money for the rest of your life.

Here’s how it works in practice. You invest a lump sum, typically into an investment bond, which is then held in trust for your chosen beneficiaries. At the same time, you set up regular withdrawals (usually within the standard 5% tax-deferred allowance) which are paid back to you as “income” (actually a return of capital, not an investment return) for life. Because you’re retaining that right to income, the provider doesn’t treat the whole sum as leaving your estate. Instead, based on your age, health and the income you’ve chosen, they calculate a “discount”: broadly, the capitalised value of the payments you’re expected to receive back over your lifetime. That discount is what’s immediately removed from your estate for IHT purposes. The rest is treated as a normal gift, which only falls outside your estate if you survive seven years.

A word on how the discount is worked out. It’s based on medical underwriting (your age, health, and life expectancy) combined with prevailing interest rates at the time, and it’s specific to you and the provider you use. Assuming a 75-year-old investing £500,000 and wanting to draw £20,000 a year could achieve an immediate discount in the region of 35%; this would mean the amount treated as a gift for IHT purposes was reduced to somewhere around £320,000 to £325,000. I want to be upfront that figures like this move around with the underwriting outcome and the provider’s rates at the time. It’s an illustration of the principle, not a number to plan against without your own underwriting.

There’s rarely a silver bullet in IHT planning

This is the bit I always come back to with clients: inheritance tax planning isn’t about finding the one clever structure that solves everything. It’s about understanding the full range of tools available (gifting out of surplus income, use of the nil rate bands, trusts, pension planning, business relief where appropriate) and working out which combination actually fits your situation, your family, and what you’re trying to achieve.

At Smith & Pinching, that’s how we approach it. We don’t start from “here’s a product.” We start from where you are, what matters to you, and then look across the full suite of options, DGTs included, to see where, if anywhere, they earn their place.

Where a DGT genuinely earns its place

In my experience, DGTs tend to work best in three fairly specific situations.

When you want to keep some income while doing IHT planning. A lot of the gifting strategies I discuss with clients ask them to give money away and simply do without it. That’s not realistic for everyone; plenty of people need the income from their capital to maintain their lifestyle. A DGT is one of the few structures that lets you reduce your estate and keep a guaranteed income stream from the same pot of money.

When the immediate discount genuinely moves the needle. Unlike most gifting, where you have to survive seven years before anything changes for IHT purposes, a DGT gives you an immediate reduction in your estate: the discounted amount is out from day one. For some clients, that immediacy is the whole point.

When you’re just over the £2 million residence nil rate band taper. This is where I think DGTs are at their most effective, and it’s worth explaining why. The residence nil rate band (RNRB), worth up to £175,000 per person on top of the £325,000 standard nil rate band, starts to taper away by £1 for every £2 your estate exceeds £2 million, and is lost entirely once your estate reaches £2,35 million. For a couple where the full allowance passes to the surviving spouse, the combined RNRB of up to £350,000 is not fully extinguished until the estate on the second death exceeds £2.7 million, meaning the taper can cost a couple up to £350,000 of combined relief across that range. If you’re sitting just over that £2m line, reducing your estate, even by a relatively modest amount, can reinstate some or all of that relief, on top of the direct saving from the gift itself. Because a DGT lets you do that reduction while keeping an income, it’s a particularly good fit for this group.

There’s also a fourth situation I’m increasingly discussing with clients: pension tax-free cash. From 6 April 2027, most unused pension funds and death benefits are due to be brought into the value of your estate for inheritance tax purposes, a significant change from the current position, where pensions generally sit outside your estate. For clients who are going to have pension wealth exposed to IHT for the first time, taking tax-free cash and using it to fund a DGT is one of the ways we’re helping people plan ahead of that change, reducing pension-driven IHT exposure while still retaining an income from the money withdrawn.

And the drawbacks, because there are some.

I wouldn’t be doing my job properly if I only told you the good bits.

• The income is fixed. Once you’ve set the withdrawal level, you can’t flex it up if your needs change later. If you think you might need more capital access down the line, that inflexibility matters.
• You can’t get the capital back. The money is gone into trust. You retain the income, not the underlying capital; if your circumstances change and you need a lump sum, it generally isn’t there for you to draw.
• The discount isn’t guaranteed to be large or available to all. It depends on underwriting. Younger, healthier clients typically get a smaller discount (because they’re expected to receive income for longer), and in some cases, such as poor health or age 90 and over, no discount may be available at all.
• It still relies on the underlying investment. The trust fund is usually invested, most commonly via an investment bond, so its value can go up or down. The value of investments can go down as well as up. It isn’t guaranteed, so you may get back less than invested.
• It’s not right for everyone with an estate over £2m. Some clients are better served by other tools: gifting from income, business relief. Or simply not touching capital they might need later. This is exactly why we look at the full picture rather than reaching for one structure.

A quick illustrative example

 Take a professional couple in their mid-70’s, combined estate around £2.3m, home included. They’re just inside the RNRB taper zone and losing part of their allowance as a result. They also want to keep some income from their savings rather than gifting outright. A DGT, structured jointly, could let them reduce their estate immediately by the discounted amount, start to reinstate some of the lost RNRB, and continue drawing a fixed income from the invested capital. It wouldn’t solve their entire IHT position on it’s own; it rarely does. But as one part of a wider plan, alongside their wills, gifting strategy and pension arrangements, it can make a real difference. (Illustrative only, not a real client.)

Discounted Trust FAQs

What is a discounted gift trust?

It’s a trust structure where you gift a lump sum but retain the right to fixed regular payments for life. A provider calculates a “discount” based on your age, health and the income you’ve chosen, and that discounted amount is immediately removed from your estate for inheritance tax purposes, ahead of the usual seven-year rule for the remainder.

How is the discount on a DGT calculated?

It’s based on medical underwriting, your age, state of health and life expectancy, combined with the level of income you want to draw and prevailing rates at the time. It’s specific to you and the provider, so the same amount invested by two different people can produce very different discounts.

Is a discounted gift trust right for everyone with a large estate?

No. It tends to suit people who want to keep an income from their capital while reducing their estate, particularly those affected by the £2 million residence nil rate band taper. Others may be better served by different tools, such as gifting from surplus income or reviewing how assets are structured. An adviser can assess whether a DGT suits your circumstances.

Can I access the capital in a discounted gift trust if I need it later?

Generally, no. You retain the right to the fixed income you’ve selected, but the underlying capital has been gifted into trust for your beneficiaries. This lack of flexibility is one of the main drawbacks to weigh up before proceeding.

Why are discounted gift trusts relevant to the 2027 pension inheritance tax changes?

From 6 April 2027, most unused pension funds and death benefits are due to be brought into the value of your estate for inheritance tax purposes. Some clients are using pension tax-free cash ahead of that change to fund planning such as a DGT, reducing future IHT exposure while retaining an income from the money withdrawn.