What Is a Discretionary Trust? UK Tax and Estate Planning Guide

A discretionary trust is a type of trust in which the trustees have discretion over how trust income and, depending on the trust deed, capital are distributed among the beneficiaries. Unlike a bare trust, beneficiaries do not normally have an automatic right to a particular asset or a fixed share of the trust fund. Discretionary trusts can provide flexibility where the person creating the trust does not want to decide immediately how assets should ultimately be divided. However, this flexibility comes with important tax and administrative responsibilities. Trusts sit within the wider Inheritance Tax and estate planning framework explained in our ultimate guide to personal tax in the UK. For 2026/27, trustees and settlors need to consider Income Tax, Capital Gains Tax (CGT), Inheritance Tax (IHT) and Trust Registration Service requirements.

What Is a Discretionary Trust?

A trust is a legal arrangement under which trustees manage assets for beneficiaries according to the terms of a trust deed or other governing document. The person who puts assets into the trust is known as the settlor, while the people or organisations who may benefit are the beneficiaries. With a discretionary trust UK arrangement, the trustees are given powers to make decisions about the trust property. Depending on the trust deed, they may decide:

• Which beneficiaries receive payments.
• Whether income or capital is distributed.
• How much an individual beneficiary receives.
• When payments are made.
• What conditions should apply to a distribution.

This differs from a trust where a beneficiary has a fixed or immediate entitlement to particular assets or income.

How Discretionary Trusts Work

Understanding how discretionary trusts work requires considering the different roles of the settlor, trustees and beneficiaries. The settlor transfers assets into the trust and establishes the terms governing how those assets should be managed. Those terms are usually contained in the trust deed. The trustees then become responsible for administering the trust in accordance with those terms. They may have significant discretion, but this does not mean they can use the trust property however they wish. Their decisions must be made within the powers granted by the trust and in accordance with their legal duties. The beneficiaries are the people or organisations who may benefit from the trust. In a discretionary arrangement, being named as a potential beneficiary does not normally mean that person can demand a particular payment or asset from the trustees.

Why Are Discretionary Trusts Used?

A discretionary trust can be useful where flexibility is more important than giving beneficiaries an immediate fixed entitlement. For example, a trust may be established where:

• Children or grandchildren may need different levels of financial support in the future.
• A beneficiary is too young to manage substantial assets.
• The settlor is concerned about a beneficiary’s ability to manage money responsibly.
• Future family circumstances are uncertain.
• The settlor wants trustees to consider beneficiaries’ circumstances before making distributions.

A grandparent, for example, might establish a discretionary trust for several grandchildren rather than allocating identical fixed amounts. Farming families sometimes use a similar structure for agricultural assets, though this should be considered alongside the separate overview of IHT Agricultural Relief. The trustees could then provide greater financial support to a grandchild who later has a particular educational, housing or other financial need.

Discretionary Trust vs Bare Trust

The distinction between a discretionary trust and a bare trust is important. Under a bare trust, the beneficiary generally has an immediate and absolute entitlement to the trust capital and income, subject to age and legal capacity. The trustee essentially holds the assets on that beneficiary’s behalf. With a discretionary trust, no individual beneficiary normally has the same automatic entitlement. Trustees instead decide whether and when distributions should be made within the terms of the trust. This additional flexibility is one reason discretionary trusts are used in family and estate planning, but it also results in different discretionary trust tax rules.

Inheritance Tax on a Discretionary Trust

Most assets held in discretionary trusts fall within the Inheritance Tax relevant property regime. This means IHT can potentially arise at more than one stage of the trust’s life. HMRC identifies three particularly important events:

• When assets are transferred into the trust.
• On each ten-year anniversary of the trust.
• When relevant property leaves the trust, potentially creating an exit charge.

HMRC’s current guidance on trusts and Inheritance Tax explains how relevant property, ten-year anniversary charges and exit charges apply to trusts. The precise IHT calculation can be complex because it can depend on the value transferred, previous chargeable transfers made by the settlor, reliefs available and the history of the trust. Where the trust holds agricultural or business property, the recent changes to Agricultural and Business Property Relief may also affect the calculation.

Inheritance Tax When Assets Enter the Trust

Transferring assets into a discretionary trust during a settlor’s lifetime will normally be a chargeable lifetime transfer for Inheritance Tax purposes. Whether tax is actually payable at that stage depends on the value transferred and the settlor’s circumstances, including relevant transfers made during the preceding seven years and any applicable exemptions or reliefs. This is different from an outright gift to an individual that may qualify as a potentially exempt transfer. Creating a discretionary trust should therefore not be treated as a simple way of removing assets from an estate without considering the immediate IHT consequences. Where the trust holds qualifying business assets, it’s also worth reviewing whether Business Relief for Inheritance Tax could reduce the value transferred into the trust.

Ten-Year Inheritance Tax Charges

Relevant property held within a discretionary trust can be subject to an IHT charge on each tenth anniversary of the trust. The calculation considers the net value of relevant property immediately before the anniversary together with other factors required under the relevant property regime. The effective rate can be up to 6%, although the actual liability depends on the circumstances of the trust. Trustees should therefore maintain accurate valuations and records rather than waiting until the tenth anniversary to reconstruct the trust’s history.

Exit Charges When Assets Leave the Trust

An IHT exit charge, technically a proportionate charge, may arise when relevant property leaves a discretionary trust, including where trustees distribute capital to a beneficiary. The calculation is not simply a fixed percentage of every distribution. The rate depends on factors including when the distribution occurs and the previous IHT position of the trust. The rate can be up to 6%. Trustees considering substantial distributions should therefore check the tax position before transferring assets to beneficiaries.

Discretionary Trust Income Tax in 2026/27

Trustees are responsible for paying Income Tax on income received by an accumulation or discretionary trust. For 2026/27, HMRC states that discretionary trust income is generally taxed at:

• 45% on non-dividend income.
• 39.35% on dividend-type income.

Most trusts have a £500 tax-free amount for income, although special rules apply where a settlor has created more than one accumulation or discretionary trust. The allowance can be divided between trusts and is limited to £100 per trust where five or more such trusts exist.

What Happens When Income Is Paid to a Beneficiary?

Income distributions from discretionary trusts have their own tax treatment. When trustees make a discretionary payment of income, HMRC generally treats the beneficiary as receiving that income with tax already paid at 45%. The trust’s tax pool is used to track whether the trustees have paid sufficient Income Tax to support the tax credit attached to distributions. Depending on the beneficiary’s own tax position, they may be able to reclaim some or all of the tax treated as deducted. This makes the timing and classification of payments important for both trustees and beneficiaries.

Capital Gains Tax on Discretionary Trusts

Trustees may also face Capital Gains Tax when trust assets such as shares or property are sold or otherwise disposed of at a gain. For the 2026/27 tax year, the trust annual exempt amount is generally £1,500. A higher £3,000 amount can apply to qualifying trusts for vulnerable beneficiaries. Reliefs may be available in particular circumstances. For example, Hold-Over Relief can sometimes defer a gain when assets are transferred rather than requiring the trustees to pay CGT immediately. Eligibility should be considered for the particular asset and transaction.

Does a Discretionary Trust Need to Be Registered?

Many UK trusts must be registered with HMRC through the Trust Registration Service (TRS), including trusts that do not currently have a tax liability unless a specific exclusion applies. Registration requirements depend on factors including when the trust was created, whether it is taxable and whether it falls within an excluded category. HMRC’s current guidance warns that failure to register a trust when required can result in a penalty of up to £5,000. Trustees should therefore check registration requirements when the trust is established and review the TRS information when relevant details change.

Records Trustees Should Maintain

Managing a discretionary trust requires more than keeping details of the assets currently held. Trustees should retain a clear history of the trust and the decisions made. Useful records can include:

• The trust deed and subsequent deeds or amendments.
• Details of the settlor and beneficiaries.
• Records of assets transferred into the trust.
• Bank and investment statements.
• Income and expense records.
• Asset valuations.
• Trustee resolutions and distribution decisions.
• Records of payments made to beneficiaries.
• Income Tax and Capital Gains Tax calculations.
• Inheritance Tax calculations for relevant chargeable events.
• Trust Registration Service records.

Accurate records become particularly important when calculating ten-year and exit charges because historical transactions can affect the eventual tax calculation.

Common Discretionary Trust Tax Mistakes

• Assuming beneficiaries own a fixed share of the trust assets.
• Transferring assets into a trust without considering the immediate IHT consequences.
• Assuming putting assets into trust automatically removes them from IHT without checking what qualifies for IHT Business Relief first.
• Overlooking ten-year anniversary charges.
• Making capital distributions without checking for an IHT exit charge.
• Applying individual Income Tax rates to income retained by trustees.
• Failing to maintain the discretionary trust tax pool correctly.
• Missing Trust Registration Service requirements.
• Failing to obtain appropriate asset valuations for tax purposes.

When a Discretionary Trust May Be Appropriate

A discretionary trust can provide valuable flexibility where a settlor wants assets to be preserved for a group of beneficiaries without deciding immediately who should ultimately receive particular amounts. However, the decision should not be based solely on potential Inheritance Tax planning. Trustees take on continuing legal and administrative responsibilities, while the trust itself can be exposed to Income Tax, Capital Gains Tax and the relevant property IHT regime. Before establishing a discretionary trust UK arrangement, the settlor should therefore consider the purpose of the trust, the assets being transferred, the intended beneficiaries, how long the trust may operate and the likely tax consequences. Existing trusts should also be reviewed before major distributions and approaching ten-year anniversaries.

Case Study: Using a Discretionary Trust for Flexible Family Planning

David approached our Fulham Broadway office while considering placing investments into a discretionary trust for his three grandchildren. He wanted the trustees to have flexibility over when and how much each grandchild received, rather than giving each beneficiary an immediate fixed entitlement.

Cigma Accounting reviewed the proposed transfer and explained that putting assets into a discretionary trust could have an immediate Inheritance Tax consequence. We considered the value being transferred alongside David’s previous lifetime gifts and explained why the transfer should not simply be treated in the same way as an outright gift to an individual.

We also discussed the trust’s longer-term tax position. David and the proposed trustees needed to understand that relevant property could potentially face ten-year IHT charges and exit charges, while investment income and future disposals could create separate Income Tax and Capital Gains Tax liabilities.

Our team also explained the trustees’ ongoing responsibilities, including maintaining records of income and distributions, monitoring the trust tax pool, obtaining appropriate asset valuations and dealing with Trust Registration Service requirements. As part of the wider review, Cigma Accounting considered David’s personal tax, investment taxation, Inheritance Tax and estate planning position.

David was then able to discuss the trust deed with his solicitor with a clearer understanding of both the flexibility a discretionary trust could provide and the tax and administrative responsibilities that would continue throughout the life of the trust.