Using Discretionary Discounted Gift Trusts to Navigate the 2027 Pension Reforms

Reducing Your Estate Whilst Keeping an Income

If you’ve been preserving your pension to pass on wealth tax efficiently, the 2027 pension reforms may have caused concern.

From April 2027, remaining pension funds will no longer automatically sit outside your estate (some pension plans currently sit in the estate if not under a trust) when passed to your beneficiaries. That means more estates could face a significantly higher inheritance tax bill, particularly for individuals already above the nil-rate band.

In this article, we will look at how a Discretionary Discounted Gift Trust (DDGT) allows you to reduce the size of your estate while continuing to draw a fixed income, providing an alternative for using your pension for IHT planning purposes.

Let’s take a closer look at how it works.

What is a Discretionary Discounted Gift Trust?

A Discounted Gift Trust is a way of reducing the potential inheritance tax (IHT) on your estate, while still allowing you to receive a regular income for the rest of your life assuming the bond doesn’t run out. It’s a valuable option for individuals, or couples, who have a IHT liability and have more capital than they need but still require an income. However, for those who do not require an income from the trust, other planning routes will be more appropriate.

How does a DDGT work in practice?

When the trust is set up, you (the settlor) choose how much to place into the trust, which is usually funded using an investment bond. You also agree the annual payment you’d like to receive, typically set at 5 per cent of the original amount. This falls within HMRC’s tax-deferred allowance, so you can receive a regular, predictable income without paying immediate tax for 20 years.

Before the trust is created, an actuary assesses your age, health, and life expectancy to calculate the value of your lifetime right to fixed payments. This is known as the discount, and it reflects the part of the gift you retain. That portion isn’t treated as a gift for inheritance tax. Only the remaining amount, after the discount, is classed as a chargeable lifetime transfer and starts the seven-year clock for IHT planning.

Example:

You transfer £325,000 into a DDGT. An actuary values your retained right to income at £100,000. This means only £225,000 is treated as a gift for inheritance tax purposes. The £100,000 discount is immediately excluded from your estate. If you survive seven years, the remaining £225,000 may also fall outside your estate for IHT purposes.

Why this structure only suits those who still need income

Withdrawals from a DDGT are fixed at the outset and cannot be changed. If the income isn’t spent, it may build up in your estate and become subject to inheritance tax. For this reason, a DDGT is best suited to those who genuinely need and will use the income during their lifetime. It offers regular, known payments while keeping the trust assets outside your estate, and can be a useful alternative to holding excess funds in a pension.

Why it matters now

From April 2027, it is expected that pensions will no longer be excluded from your estate for inheritance tax purposes. For many families, this change will bring a significant portion of previously protected wealth into scope for inheritance tax.

Using a DDGT can offer several important benefits:

Lower your taxable estate

The value of the discount, along with any growth inside the trust, is immediately removed from your estate.

Maintain a regular income

You continue to receive fixed annual withdrawals, often up to 5 per cent of the original amount, without triggering additional income tax for up to 20 years or affecting the trust’s tax position.

Keep control within the family

Trustees have full discretion over how and when funds are passed to beneficiaries. This offers protection in the event of divorce, debt, or vulnerability.

Start the clock early

Gifts into a DDGT are not potentially exempt transfers. They are classed as chargeable lifetime transfers. The seven-year clock starts from the date of the gift, and acting now gives your planning more time to work.

Understanding the tax treatment

Matthew Whittam, Financial Adviser at Hawsons Wealth Management, explains: “For clients who want to reduce inheritance tax but still need access to a regular income, a Discretionary Discounted Gift Trust can offer a well-balanced solution. It’s about making your money work for you without losing sight of your personal circumstances and long-term goals. Although a Discretionary Discounted Gift Trust can be a very effective way to reduce your inheritance tax liability following the pension changes, it may not be suitable for everyone. We always recommend taking professional advice to make sure it supports your wider financial planning goals.”

Here are some important points to consider:

Relevant property regime

DDGTs are taxed under the relevant property rules. This means there may be small charges (subject to the value invested) every ten years and when capital leaves the trust. These are based on the value of the trust fund at the time.

Immediate tax if you exceed the nil-rate band

If the discounted gift plus any other chargeable lifetime transfers in the last seven years exceeds your available nil-rate band, then tax is paid at 20 per cent on the excess.

What happens if you die within seven years?

If the settlor dies within seven years, the discounted portion remains outside the estate, but the rest of the gift is added back in and may be subject to inheritance tax. Taper relief can reduce this after three years.

Spending the income

Any discounted income you receive from the trust must be spent. If you leave it sitting in your account or reinvest it, it will simply remain part of your estate and may be taxed when you pass away.

Final thoughts

The 2027 expected pension changes have made estate planning more urgent, but not unmanageable.

If your aim is to pass on wealth efficiently, while keeping some income during retirement, a DDGT may be worth considering. It provides clarity, control, and an opportunity to manage inheritance tax risk in a structured and flexible way.

As always, this type of planning should be personalised. The most effective strategies are those built around your income needs, your estate size, and the legacy you wish to leave.

If you would like to talk through how a DDGT could work for your circumstances, we are always happy to help.

“The value of your investments can fall as well as rise. You may not get back what you invest. The content on this page does not constitute financial advice.”

“The information contained within this article is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.”

Related content