Discounted Gift Trusts: a smart estate planning strategy 

Can you ‘have your cake and eat it’ when it comes to Inheritance Tax planning? Some would say that a Discounted Gift Trust (DGT) is an effective way to do so. Of course, one thing is certainly true: efficient financial planning is essential if you wish to pass on your assets to your loved ones with minimum sums lost to the taxman.

Last week, we considered how the upcoming Autumn Budget might lead to significant changes in this area. We also touched upon the use of trusts to protect family wealth as tax bills rise. DGTs are a powerful tool, although there are alternatives. This article focuses primarily on how a DGT works and whether it might be suitable for you.

What is a Discounted Gift Trust (DGT)?

A DGT is financial planning arrangement that allows you to make a gift into a trust and reduce the value of your estate for Inheritance Tax (IHT) purposes. Its major benefit over other trusts is that a portion of this gift may become immediately exempt from IHT. The remainder of the gift will become fully exempt from IHT after seven years. Crucially, this type of trust also allows for fixed payments for life to the person making the gift. This means that you can reduce eventual Inheritance Tax, while still receiving payments from the capital.

Why is the gift ‘discounted’?

As you retain the right to receive payments for the rest of your life, the potential value of these payments is not regarded by HMRC as being lost to your estate. This therefore reduces the value of the gift for IHT purposes. The reduction is calculated on an actuarial basis by the scheme provider, and takes into account your age, health and level of withdrawals. This means that if you’re relatively young, and in good health, the discount could be significant.

Key Benefits of a DGT

• Immediate IHT reduction: a portion of the gift is considered outside your estate from day one — this is known as the discount
• Regular withdrawals: you retain access to fixed capital withdrawals, providing a long-term ‘income’ stream. You may wish to supplement your pension in this way.
• Control and flexibility: trustees manage the assets on your behalf, and you can appoint your own or use professional services,
• Investment Growth: trust assets can grow over time, increasing the value passed to beneficiaries. Any growth is outside your estate from day one.

How Does It Work?

1. Set up a trust: you create a trust and transfer a lump sum into it. The trust can either be a bare trust, with specific beneficiaries which you cannot change. Alternatively, a discretionary trust can be used. This is a more flexible structure which allows for the trustees to have control over the distribution of assets, but a portion of the gift may be subject to an immediate IHT charge if it exceeds your available ‘Nil Rate Band’ (£325,000).

2. Actuarial assessment: the amount of discount depends on your age, health, and income level.

3. Investment: the lump sum is generally invested in a UK or offshore investment bond, so that any income generated within the bond is not immediately taxable on the trustees.

4. Regular payments: you receive fixed capital withdrawals from the bond.

5. Trustee Management: trustees oversee the bond and appoint investment managers to align with the trust’s objectives.

Case study

Mr. Smith, aged 70, has an estate worth £700,000. He gifts £200,000 into a discretionary DGT and opts for £10,000 annual withdrawals. A discount of £98,200 (49%) is calculated and deducted from the value of the gift. The remaining £101,800 is treated as a Chargeable Lifetime Transfer (CLT). His potential IHT bill is reduced by £39,280 immediately, and if he survives seven years, the full £200,000 may be excluded — saving up to £80,000 in IHT.

Is a DGT right for you?

This is suitable for individuals who:

• Want to reduce their estate’s IHT liability.
• Seek fixed, regular payments from gifted capital.
• Are in reasonably good health.
• Do not need access to the gifted capital,
• Are comfortable with trust structures.

Not suitable for those who:

• Require flexible, ad-hoc withdrawals (a ‘flexible reversionary trust’ may be more appropriate).
• Want beneficiaries to access the investment while alive.
• May want to cash-in the bond during their lifetime.

Comparison of Trust Types

Final Thoughts

DGTs can be a highly effective solution for mitigating IHT while maintaining a form of income stream. However, it’s essential to consider your overall financial position and explore alternative solutions such as Loan Trusts, Discretionary Trusts or Flexible Reversionary Trusts. Professional advice is crucial to determine the most suitable strategy for your needs.

As AJB Wealth’s Managing Director, Paul Willans, commented: ’With the amount of IHT rising every year, and the Government looking to raise further tax, estate planning has never been more important. DGTs are an effective measure for many who want to mitigate their estate’s potential tax burden.’

For more information, or to discuss other wealth management matters, contact the AJB Wealth team. Please call us on 01428 774 070 or simply book a meeting online.

Note: This article is for information purposes only and does not constitute financial, legal, or tax advice. The content is based on AJB Wealth’s understanding of current legislation and HMRC practice as at the date of publication, which may be subject to change. The suitability of any financial planning strategy, including the use of Discounted Gift Trusts and capital redemption bonds, should be assessed in the context of your individual circumstances and objectives.