Key Takeaway
For DGTs, Absolute Trusts usually avoid the 14‑year IHT trap, making them safer for clients who want instant IHT reduction without risking CLT interactions. Discretionary Trusts offer flexibility, but introduce CLT treatment — which can unexpectedly pull earlier gifts back into charge for up to 14 years, not 7.
1. What a DGT Achieves
A Discounted Gift Trust allows a client to:
-
Reduce their IHT liability immediately (via the actuarial discount)
-
Retain up to 5% p.a. withdrawals for life
-
Pass 100% of the investment value to beneficiaries
-
Move the full value outside the estate after 7 years
The discount (10–60% depending on age/health) is treated as the settlor’s retained right to withdrawals. The remainder is treated as a gift into trust.
2. The Trust Choice: Absolute vs Discretionary
Absolute (Bare) Trust
Beneficiaries have a fixed, unchangeable right to the trust assets.
Pros
-
PET treatment → 7‑year rule only
-
No periodic or exit IHT charges
-
Lower tax rates (beneficiary’s personal rates)
-
Simple administration
Cons
-
Beneficiaries gain full access at 18 (16 in Scotland)
-
No ability to change beneficiaries later
-
Assets exposed to beneficiary divorce/bankruptcy
Discretionary Trust
Trustees choose who benefits, when, and how much.
Pros
-
Maximum flexibility for changing family circumstances
-
Strong asset protection
-
Ideal for blended families, vulnerable beneficiaries, or future uncertainty
Cons
-
CLT treatment → triggers the 14‑year rule
-
Periodic and exit charges
-
Higher trust tax rates
-
More administration
3. Why Discretionary Trusts Create the 14‑Year Rule
PET vs CLT
-
Absolute Trust gift = PET → Only the 7‑year rule applies
-
Discretionary Trust gift = CLT → CLTs accumulate over 7 years → A failed PET can “catch” earlier CLTs → This creates an effective 14‑year window
The Mechanism
If a client:
-
Makes a CLT (e.g., DGT using discretionary wording)
-
Then makes a PET within the next 7 years
-
Dies within 7 years of the PET → The PET fails and becomes a CLT → It pulls in the earlier CLT → Both gifts are tested against the NRB → Potential IHT becomes payable
This is how a gift made 13 years and 11 months ago can still affect today’s IHT bill.
4. Worked Example
Timeline
-
01/06/2012 – £300k DGT using Discretionary Trust → CLT (below NRB → no tax)
-
01/05/2019 – £300k gift to daughter → PET
-
30/04/2026 – Death (6 years 11 months after PET)
Outcome
-
PET fails → becomes CLT
-
It “catches” the 2012 CLT
-
Total CLTs = £600k
-
NRB = £325k
-
Excess = £275k
-
IHT @ 40% = £110k
-
Taper relief (80%) = £88k
-
Tax payable = £22k
Client Impact
A trust chosen for flexibility created an unexpected £22,000 tax bill — despite the client believing they were within the 7‑year rule.
5. Summary Table
a. Avoid Discretionary Trust wording for DGTs unless flexibility is essential
Use Absolute Trusts for:
-
Straightforward family structures
-
Clients prioritising IHT efficiency
-
Situations where the 14‑year rule is unacceptable
Use Discretionary Trusts only when:
-
Beneficiary circumstances may change
-
Asset protection is critical
-
Trustees need long‑term control
b. Keep PETs and Absolute‑Trust DGTs at least 7 years away from any CLTs
This prevents:
-
Failed PETs pulling earlier CLTs into charge
-
The 14‑year rule from activating
c. Sequence gifts correctly
Correct order:
-
PETs first
-
Absolute‑Trust DGTs next
-
CLTs (including Discretionary‑Trust DGTs) last
This ensures:
-
The 7‑year clock starts early
-
CLTs do not contaminate earlier PETs
-
Maximum IHT efficiency
7. Final Recommendation Framework
Choose an Absolute Trust when:
-
You want the clean 7‑year rule
-
Beneficiaries are stable and known
-
You want no periodic charges
-
You want simplicity
Choose a Discretionary Trust when:
-
You need flexibility for future changes
-
You want asset protection
-
You accept CLT treatment and possible periodic charges
-
You understand and accept the 14‑year rule risk
Our Fees: Discounted Gift Trust Investment Advice
Gift Trust
Contact Book Appt Calculators Our Fees
