Inheritance tax with a Discounted Gift Trust
Peter McGahan
Monday 12th October, 2026.
FANCY title, but bear with me. The easiest way to get money out of your estate is to give it away, but most people have developed the inconvenient habit of needing money to live on. Long sigh.
Give £500,000 to your children and, assuming it's a potentially exempt transfer, survive seven years and it will normally fall outside your estate for inheritance tax purposes.
Simple.
Except you no longer have £500,000.
What if that capital is surplus to your long-term needs, but you still need £20,000 or £25,000 a year from it? You can't give someone your cake and continue eating it. HMRC spotted that one some time ago.
This is precisely the problem a Discounted Gift Trust (DGT) is designed to tackle.
Typically, a lump sum is invested into an investment bond held within a specially designed trust. You retain clearly defined rights to predetermined capital payments for life. Everything else is held for the beneficiaries.
Suppose you invested £500,000 and retained the right to five per cent - £25,000 annually.
The clever bit - you haven't really given away the entire £500,000 because you've kept something valuable: the contractual right to those future payments.
So that retained right is then valued.
Your age and health are important because the value depends partly on how long you're expected to receive those payments. HMRC looks at the open-market value of the retained rights (the money due back to you). If, purely for illustration, they were valued at £175,000, your initial gift wouldn't be £500,000. It would be £325,000.
That's the ‘discount’.
That produces the first significant inheritance tax benefit.
If you died before seven years had passed, it is the discounted gift – £325,000 in my example – rather than the original £500,000 that is potentially relevant to the lifetime transfer calculation, subject of course to the type of trust used and your circumstances.
Survive seven years, and, with a bare-trust version, the potentially exempt transfer normally falls out of the inheritance tax calculation altogether.
Meanwhile, the growth belongs within the trust rather than accumulating in your personal estate.
The clever part is what happens to your retained rights.
You only receive each future payment if you survive to its payment date. When you die, there aren't another 15 years of payments sitting in your estate waiting to be taxed. Your future entitlement has ended.
So, a DGT can potentially give you an immediate reduction in the amount transferred for inheritance tax purposes, move future investment growth out of your estate and eventually remove the discounted gift too, while providing predetermined payments back to you during your lifetime.
The handcuffs?
You cannot have open access to the original capital. The whole tax logic depends upon genuinely giving away the part belonging to the beneficiaries.
If you put £500,000 into the arrangement and subsequently decide you'd quite like £100,000 back for a motorhome, house extension or unusually enthusiastic cruise, the trustees cannot simply hand you the beneficiaries' money.
That's why deciding how much you need before entering the arrangement matters considerably more than the tax saving.
There is another choice to make over the trust itself – techy bit.
A bare trust can mean the discounted gift is a potentially exempt transfer, but the beneficiaries are fixed. That might be fine if you're certain who should eventually receive the money.
A discretionary or flexible arrangement gives considerably greater control over who ultimately benefits, but that flexibility comes with its own inheritance tax regime. The discounted gift is generally a chargeable lifetime transfer and there can potentially be 10-year periodic and exit charges.
Tax planning rarely hands out flexibility for free.
There are investment considerations too. Charges, investment risk, bond taxation and the sustainability of withdrawals all need assessing. Regular payments can slowly eat into the investment if growth doesn't keep pace.
And that's why I wouldn't start with the tax.
Start with your expenditure.
Work out what capital you could genuinely surrender access to, what payments you will need for the rest of your life and what financial surprises you should retain money elsewhere to cover. Only then calculate whether the potential inheritance tax saving justifies the restrictions, costs and complexity.
A DGT is an unusual compromise: you can give away part of the value today while keeping a predetermined financial benefit for yourself.
The tax saving is useful.
Making sure you haven't given away tomorrow's financial security is rather more important.
I am writing an inheritance tax guide, if you would like a complimentary copy when it is ready, please email info@wwfp.net
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
