SHORT ANSWER. Discretionary Trusts are separate legal things which own property independently of the trustees and the beneficiaries. The Trustees decide which Beneficiaries to give the trust assets and income to, how much they get and when they get it. It is a similar idea to a company with Directors, Shareholders and Dividends. This page gives you details about how the work and and update of recent changes to the law on discretionary trusts.
Learn how discretionary trusts offer flexibility and tax efficiency — plus the exact rates, charges, and real-life examples you need before setting one up
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Introduction
Discretionary trusts remain one of the most powerful and flexible tools available in UK estate planning in 2026. They allow trustees to decide who receives income or capital — and when — giving families greater control over their wealth across generations.
In this comprehensive guide, we explain how discretionary trusts work, their tax implications for Inheritance Tax (IHT), Income Tax and Capital Gains Tax (CGT), real-life examples, and practical considerations to help you decide if this structure is right for your circumstances.
What Is a Discretionary Trust?
A discretionary trust is a legal arrangement where the trustees hold assets for the benefit of a group of potential beneficiaries. The trustees have full discretion over:
- Which beneficiaries receive payments
- How much they receive
- When payments (income or capital) are made
This differs significantly from other common trusts:
- Bare Trusts (also called simple or absolute trusts): The beneficiary has an immediate and absolute right to both the income and capital (usually from age 18 in England and Wales). The trustee acts as a nominee with very little control.
- Interest-in-Possession Trusts (IIP): A named beneficiary (the “life tenant”) has an immediate right to the income generated by the trust assets, while the capital is preserved for other beneficiaries (often called remaindermen).
Discretionary trusts offer the greatest flexibility but come with more complex tax rules under the “relevant property” regime.
Key Benefits of Discretionary Trusts in 2026
Discretionary trusts provide several important advantages:
- Flexibility — Trustees can adapt distributions to changing family circumstances, needs, or tax positions.
- Asset Protection — Assets are protected from beneficiaries’ creditors, divorce settlements, or poor financial decisions.
- IHT Planning — They can help manage exposure to Inheritance Tax, particularly for larger estates or when using business/agricultural property reliefs.
- Support for Vulnerable Beneficiaries — Ideal for protecting young children, those with disabilities, or family members who may need controlled access to funds.
- Control Across Generations — You can ensure wealth is preserved rather than distributed outright too early.
Do Discretionary Trusts Save Tax? The Honest Picture
Discretionary trusts are not a simple tax-avoidance vehicle. They can be tax-efficient in the right circumstances, particularly for Inheritance Tax planning and asset protection, but they also attract higher rates of tax on income and gains compared to personal ownership.
Used correctly — with professional advice — they can deliver meaningful tax savings and peace of mind. Used incorrectly, they can create unnecessary tax charges and administrative burdens. The key is matching the trust to your specific family and financial goals.
Inheritance Tax (IHT) Rules for Discretionary Trusts
Discretionary trusts fall under the relevant property regime, which imposes three main potential IHT charges:
Entry Charge (20%)
When assets are transferred into the trust during the settlor’s lifetime, it is treated as a Chargeable Lifetime Transfer (CLT). Transfers up to the available nil-rate band (£325,000 in 2026) are taxed at 0%. Amounts above this are charged at 20%. If the settlor dies within 7 years, additional tax may be due.
10-Year Periodic Charge (up to 6%)
Every 10 years, the trust is subject to a periodic (or “principal”) charge. This is calculated on the value of trust assets exceeding the available nil-rate band, at a maximum effective rate of 6%.
Exit Charges
When capital leaves the trust (e.g., distributions to beneficiaries), a proportionate charge may apply, up to a maximum of 6%, depending on the time elapsed since the last 10-year anniversary.
The 7-Year Rule & Nil Rate Band
The settlor’s nil-rate band and any Chargeable Lifetime Transfers made in the previous 7 years affect both entry and periodic charges.
Income Tax on Discretionary Trusts
Trustees pay tax on income at the trust rates:
- 45% on non-dividend income
- 39.35% on dividend income
There is a small standard rate band (often £500 or split between trusts created by the same settlor). When income is distributed to beneficiaries, they receive an R185 tax credit (at 45%), which they can use to reclaim tax if they are basic-rate or non-taxpayers.
Capital Gains Tax (CGT) and Discretionary Trusts
Trustees pay CGT at 24% on most gains (as of 2026). The trust receives half the individual annual exempt amount (shared among trusts created by the same settlor). Hold-over relief may be available on certain transfers, particularly business assets.
Real-Life Example: Commercial Property in a Discretionary Trust
Consider a commercial property worth £200,000 with a base cost of £80,000, placed into a discretionary trust.
- On entry: If within the nil-rate band, no immediate IHT. Otherwise, 20% on the excess.
- Future growth: Any capital growth occurs inside the trust and can be managed flexibly.
- On a future sale or distribution: Trustees pay CGT at 24%. Hold-over relief can defer the gain in some cases.
- IHT benefit: The property (and its future growth) is removed from the settlor’s estate, potentially saving 40% IHT on death, subject to the relevant property charges.
This structure can be particularly powerful when combined with Business Property Relief.
Tax Efficiency Comparison
Example 1: Low-income beneficiary (with reclaim)
A beneficiary in the nil or basic-rate band receives a distribution. They can often reclaim most or all of the 45% tax already paid by the trustees via their self-assessment.
Example 2: Higher-rate taxpayer
A higher/additional-rate beneficiary receives the distribution with limited or no further tax to pay (after the 45% credit).
Side-by-side Comparison Table (suggest adding a clean HTML table here):
| Scenario | Direct Ownership | Discretionary Trust | Key Advantage |
|---|---|---|---|
| IHT on Death | 40% on estate | Removed from estate (subject to trust charges) | Strong IHT planning |
| Income Tax | Personal rates | 45% trustee rate + possible reclaim | Flexible for low-rate beneficiaries |
| CGT on Sale | 18%/24% | 24% trustee rate | Hold-over relief possible |
| Asset Protection | Limited | High | Creditor / divorce protection |
Common Pitfalls and Compliance Requirements
- Trust Registration Service (TRS): Most discretionary trusts must be registered with HMRC. Failure to register can result in penalties.
- Anti-avoidance Rules: General Anti-Abuse Rule (GAAR) and other provisions can challenge aggressive planning.
- Record-keeping and Reporting: Trustees must maintain detailed records and file tax returns (Trust and Estate Tax Return) when required.
- 10-year anniversaries: Missing periodic charge calculations can be costly.
Always ensure the trust deed is professionally drafted and reviewed regularly.
Is a Discretionary Trust Right for You in 2026?
Pros: Flexibility, asset protection, IHT planning potential, control over distributions.
Cons: Higher ongoing tax rates, administrative complexity, periodic and exit charges.
A discretionary trust is often suitable for families with estates above the nil-rate band, business assets, vulnerable beneficiaries, or those seeking long-term wealth protection.
Frequently Asked Questions
1. Can I put my house into a discretionary trust?
Yes, but it may trigger IHT charges and lose certain reliefs (e.g., main residence relief in some cases). Specialist advice is essential.
2. How much does it cost to set up a discretionary trust?
Legal fees typically range from £1,500–£5,000+ depending on complexity, plus ongoing trustee and tax compliance costs.
3. Do beneficiaries pay tax on distributions?
They receive income with a 45% tax credit. Higher-rate taxpayers usually pay little extra; lower-rate taxpayers may reclaim tax.
4. What is the 10-year charge?
A potential IHT charge of up to 6% on the value of trust assets exceeding the nil-rate band, every 10 years.
5. Are discretionary trusts still worthwhile after recent tax changes?
Yes, particularly for asset protection and targeted IHT planning, though the tax landscape requires careful modelling.
6. Can trustees be family members?
Yes. Many families appoint a mix of family and professional trustees.
7. What happens if the settlor dies within 7 years?
Additional IHT may become payable on the original transfer into the trust.
8. How often should a discretionary trust be reviewed?
At least every 3–5 years, or after major life or tax law changes.
Setting up or reviewing a discretionary trust is a significant decision that requires expert guidance. Contact David Buchanan for clear, practical advice tailored to your family and financial circumstances.
Related Articles and links
What is a lease?
What is a trust?
Link to the Law Society Find a Solicitor tool
| Scenario | Direct Ownership | Discretionary Trust | Key Advantage |
|---|---|---|---|
| IHT on Death | 40% on estate value | Removed from settlor’s estate (subject to trust charges) | Strong IHT planning tool |
| Income Tax | Personal tax rates (0–45%) | 45% trustee rate + R185 credit for beneficiaries | Flexible – especially for lower rate beneficiaries |
| CGT on Sale | 18% or 24% | 24% trustee rate (hold-over relief possible) | Deferral opportunities |
| Asset Protection | Limited | High protection from creditors & divorce | Significant protection |
UPDATE 01 July 2026 – MUST READ!
Key recent and upcoming changes to the taxation of discretionary trusts (including accumulation trusts) and testamentary discretionary trusts in the UK.16
Income Tax Changes (Mainly Affecting Discretionary/Accumulation Trusts)
Discretionary trusts (where trustees have discretion over distributions) and accumulation trusts are taxed at special “trust rates” on income they retain. Trustees handle the tax.31
- £500 de minimis exemption (from 6 April 2024): Trusts with total net income up to £500 per year generally pay no Income Tax and have simplified/no reporting obligations. If income exceeds £500, the full amount is taxed at trust rates (no partial relief). For settlors with multiple such trusts, the £500 limit is shared (down to £100 each if 5+ trusts).
- Abolition of the £1,000 standard rate band (from 6 April 2024): Previously, the first £1,000 of income was taxed at basic rates (20% non-dividend / 8.75% dividend). This band was removed, so all income above the de minimis is now at higher trust rates.
- Trust rates (current as of 2025/26):
- Dividend-type income: 39.35%
- All other income: 45%16
- Upcoming rate increases:
- Dividend management expenses: Rate rises from 8.75% to 10.75% from 6 April 2026 (no change to the main 39.35% trust dividend rate).
- From 6 April 2027: Savings and property income in trusts taxed at 47% (up from 45%); other non-dividend income stays at 45%. This affects things like interest, rental income, and bond gains.33
When trustees distribute income to beneficiaries, they issue an R185 form with a tax credit (typically at 45%). Beneficiaries report it on their Self Assessment and can claim a refund if their personal rate is lower.
Capital Gains Tax (CGT) for Trusts
- The annual exempt amount for trusts has been reduced: £3,000 (2023/24) → £1,500 (2024/25 onwards).
- Trustee CGT rates are generally aligned with higher rates (20% or 24% for residential property, depending on timing).
Inheritance Tax (IHT) and Relevant Property Regime
Discretionary trusts fall under the “relevant property” regime, with:
- 10-year anniversary charges (up to 6% on value above the nil-rate band).
- Exit charges on distributions.
- Lifetime transfers into the trust may incur 20% IHT (above nil-rate band).
Recent/Upcoming IHT developments (impacting trusts more broadly):
- Business/Agricultural Property Relief (BPR/APR) capped at £2.5m per person from 6 April 2026 (50% relief above that).
- Nil-rate band and residence nil-rate band frozen until 2031.
- Pensions entering IHT scope from 6 April 2027.
- Specific rules for pre- vs post-30 October 2024 trusts regarding new caps and transitional reliefs.
Offshore trusts saw major changes from 6 April 2025 linked to the end of the remittance basis (now residence-based taxation), abolition of protected foreign source income rules, etc.
Testamentary Discretionary Trusts (Will Trusts)
These are discretionary trusts created via a will (on death). They often benefit from:
- No immediate 20% lifetime IHT charge on creation (as the estate pays death-rate IHT).
- Potentially favourable treatment for asset protection and IHT planning.
Recent changes impacting them:
- They are generally subject to the same income tax rules as lifetime discretionary trusts (including the £500 exemption and high trust rates).
- Transitional protections may apply for existing trusts under IHT reforms (e.g., BPR/APR caps, relevant property charges). New or post-Budget testamentary trusts may face stricter rules in some scenarios.21
- Note: Some discussions (especially in other jurisdictions like Australia) mention minimum tax rates on testamentary trusts, but in the UK the core regime remains the relevant property rules plus the income tax changes above. Always check specific will drafting.
Practical Implications and Advice
- Administration burden: Even small trusts may need professional help for compliance, especially with distributions and periodic IHT charges.
- Planning: Consider beneficiary tax positions for distributions, use of the de minimis, and asset types (e.g., dividends vs property income). Trusts remain useful for asset protection, flexibility, and IHT mitigation but are more heavily taxed than before.
- Reporting: Use Trust Registration Service (TRS) where required; file Trust and Estate Tax Returns (SA900) as needed.
These changes stem primarily from the Spring Budget 2023, Autumn Budget 2024/2025, and Finance Acts. Rules can be complex and depend on specifics (e.g., settlor’s status, trust type, residency). This is not tax advice—consult a qualified UK tax adviser, solicitor, or accountant for your situation, and refer to official HMRC guidance (gov.uk/trusts-taxes).16
For the latest, check HMRC’s Trusts and Estates newsletters or the gov.uk trusts pages, as further tweaks may occur.