What is a discretionary trust, and should you have one?

Trust the process: how a discretionary trust works

A discretionary trust involves the same three parties as any trust (with one major difference). If you’re not familiar with these, you’re going to need to know their official names:

• First, there’s the settlor. This is the person who moves some of their assets (money, property, investments, etc) into a trust. 

• Next, there’s the trustee. The trustee is the person or group that the settlor chooses to hold and manage those assets.

• Finally, there’s the beneficiary. They’re entitled to the benefit of the assets in trust – which can mean the income the assets generate, or the assets themselves, at a later date.

The key point with a discretionary trust is that the beneficiaries aren’t named (that's the "discretionary" part), so no one has an automatic right to the assets involved or the benefit of them.

The trustees decide who gets what, but they’ll usually follow a “letter of wishes” – a note from the settlor explaining what they’d like to happen with the money.

It’s a bit like being at a wedding with an open bar: there’s a crowd of thirsty guests (the beneficiaries), but only the bartenders (the trustees) decide who gets served, what they get, and when. 

Maybe your glass is never empty, maybe your cousin’s cut off after one too many embarrassing toasts. The hosts might drop a few hints about who deserves a top-up, but in the end, the bartenders hold all the power – and nobody has a guaranteed drink.

Estate of flux: how discretionary trusts are used

Like other types of trust, discretionary trusts are often used in estate planning. This is because moving assets into a trust means that they’re no longer part of your estate, which can help to reduce your inheritance tax (IHT) bill – if you do it right.

But why would you choose a discretionary trust over a bare trust, for example, where the beneficiaries are named? Generally, so that there’s flexibility for the list of beneficiaries to change in the future. 

Bare trusts are the most straightforward kind of trust, and give you full control over who gets what. Check out our guide: Everything you need to know about bare trusts.

With a discretionary trust, trustees can choose to pay out to:

• Future family members who weren't even around when the trust was set up, like future children and grandchildren
• People who suddenly need access to funds because their situation has changed, like needing help with care or education costs.

Likewise, they can choose not to pay out to:

• People who no longer need it, perhaps because they’ve reached a certain age or become a self-made millionaire
• People who're out of the picture, like ex-partners
• People who've proven they can't be trusted with a windfall (like that cousin who once blew their student loan on crypto).

None of these decisions would be possible with a bare trust, because the named beneficiaries have an automatic right to their share and can’t lose it.

There are other important differences too, which we'll explore later on.

Death and taxes: discretionary trusts and IHT

We mentioned that trusts can help you reduce your inheritance tax bill, which, let's face it, is what most people actually care about.

When you move assets into a discretionary trust (a “transfer” in HMRC-speak), it’s called a chargeable lifetime transfer, or CLT.

If there’s any inheritance tax to pay, it’s due straight away, not after you’ve died. CLTs are taxed at half the usual IHT rate – so, 20% instead of 40%.

But just because it’s a “chargeable” transfer doesn’t mean you’ll actually owe tax.

If your transfer falls within your tax-free allowance (the nil-rate band, or NRB – currently £325,000), there’s no tax bill. Only anything above your NRB gets taxed at 20%.

Let's look at a couple of examples.

How it works with a transfer within your NRB

If you transfer £300,000 into a discretionary trust, that’s a CLT. However, you have your entire NRB available, and the whole transfer will fall within it. So, there’ll be no tax to pay. You’ll still have £25,000 of your NRB left over.

That £300,000 "counts" against your allowance for the next seven years. If you die within seven years, any other gifts or money you leave above that £25,000 will face IHT.

Survive for seven years though, and your full NRB is restored. You’ve escaped a tax bill on the entire transfer, and you have the same estate planning opportunities as you did before.  

In practice, many people use this rule to transfer up to £325,000 into a trust every seven years – dodging IHT each time and still having their full NRB available when they're finally pushing up the daisies.

The seven-year rule, in a nutshell

If you give away money or put up to £325,000 into a trust, it still counts towards your inheritance tax allowance for the next seven years.

Live for seven years after making the gift, and it’s wiped from the slate. You get your full £325,000 tax-free allowance back for the rest of your estate.

How it works when a transfer exceeds your NRB

Let's say you transfer £350,000 into a discretionary trust. The first £325,000 is covered by your tax-free allowance (the NRB), assuming you haven't made any other chargeable transfers.

The remaining £25,000 is taxed at 20%, which is a tax bill of £5,000.

Again though, after seven years, your tax-free allowance resets, and you emerge (hopefully) a little older and wiser.

Periodic and exit charges

Even after your initial transfer, discretionary trusts face a couple of extra inheritance tax “checkpoints” along the way.

The 10-year charge (the “anniversary charge”): Every decade, HMRC throws the trust a little birthday party – only instead of cake, they check the value of what’s inside and may take up to six percent of anything above the nil-rate band. This rule is there to stop people keeping money out of the inheritance tax net forever.

The exit charge: If the trust hands out assets to a beneficiary between these ten-year checkpoints, there’s often a smaller tax to pay. The exit charge is like a mini anniversary charge, calculated as a slice of what the ten-year bill would have been, based on how long the assets spent inside the trust.

When the trust winds up: If the trust is closed and everything is paid out, the exit charge applies to whatever’s left at the finish line.

While these charges might sound ominous, they’re rarely as steep as the 40% inheritance tax rate you see on ordinary estates. Still, they’re something every trustee needs to keep an eye on as part of the ongoing housekeeping that comes with running a discretionary trust.

Income tax

Discretionary trusts have a bit of a reputation for being taxed to the hilt, and it’s not entirely undeserved.

Once a trust’s income creeps past a tiny allowance (£500 a year), the taxman takes a hefty slice: 45% on most income, and 39.35% on dividends. The trustees are the ones who deal with these chunky tax bills, not the beneficiaries.

When trustees pay out to a beneficiary, though, things shift. The income is handed over with a tax credit for the tax already paid by the trust.

If the beneficiary’s own tax rate is less than the trust’s – which it often is – they can reclaim the difference from HMRC – sometimes even getting back all the tax, so their overall tax rate on the trust income is 0%. 

This is another reason discretionary trusts can be sneakily effective for income tax planning, especially if you’re hoping to help out children or relatives who don’t earn much themselves.

Capital Gains Tax

Unlike bare trusts, when a discretionary trust sells something for a profit (think shares, property, etc), it’s the trustees on the hook to pay Capital Gains Tax (CGT).

They get a tax-free allowance of £1,000 (or £3,000 if the beneficiary is classed as “vulnerable”), and anything above that is taxed at the special “trustee” rates (currently 24%).

If trustees pay out assets directly to a beneficiary – for example, transferring shares or property rather than cash – this is usually treated as if the trust sold the asset, and CGT is due.

In some cases, though, there are special rules that let the trust “hold over” the gain, so the beneficiary takes on the asset and the built-in gain – basically deferring the tax until they sell in future.

Keeping it in the family: who needs a discretionary trust?

Discretionary trusts aren’t just for people who like complicated paperwork. They’re for anyone with sizeable assets who wants to stay in the driving seat, even when they’re not around. 

Leave money outright in your will, and you have zero say over what happens next. But pop it into a discretionary trust, and you can call the shots from beyond the grave (or at least nudge things in the right direction).

Maybe you want to look after a family member who isn’t great with money, or make sure your kids benefit (and not their exes) if things go south. 

Perhaps you’re worried about a beneficiary racking up debts, and don’t fancy your legacy going straight to the bailiffs. 

Or maybe you want to set things up so even future grandchildren (or great-grandchildren you haven’t met yet) can share in what you’ve built.

That said, discretionary trusts aren’t always the answer. Bare trusts do the job if you just want to name a beneficiary and keep things simple – and cheaper. 

Let's take a closer look at how the two compare.

	Bare trusts	Discretionary trusts
Who gets the assets?	One (or more) named beneficiary gets everything, no strings	Trustees decide who gets what, when, and how much
When do they get it?	Automatically at 18 (16 in Scotland)	Whenever trustees decide –could be now, later, or never
Can you change your mind?	No. Once it’s set up, the beneficiary and shares are fixed	Yes. Trustees can add or remove beneficiaries (within limits)
Who pays tax?	The beneficiary – income and gains are taxed as if they own it	The trust pays – usually at the highest rates, then beneficiaries may reclaim some when paid out
Tax rates and allowances	Uses the beneficiary’s own allowances (income tax, CGT, etc)	Trust gets tiny allowances; most income taxed at 45%/39.35%, CGT at 20%/24%
Inheritance tax	Treated as a gift – no IHT if the settlor survives 7 years	Large gifts may trigger immediate 20% IHT charge; 10-year and exit charges apply
Control	Minimal: beneficiary can do what they like at 18	Maximum: trustees call the shots for as long as the trust runs
Admin and cost	Simple, low-cost, less paperwork	More complex, higher cost, ongoing admin and trustee duties
Best for	Straightforward gifts, saving for kids, when control isn’t needed	Protecting assets, managing family dynamics, vulnerable beneficiaries, or if you want future-proofing and flexibility

Making it happen: how to create a discretionary trust

Setting up a discretionary trust isn’t something you can – or should – do solo. You’ll need a solicitor to draw up the legal paperwork.

A good financial adviser will also be worth their weight in gold, especially if you’re juggling investments, property, or a family business. They’ll help you line everything up, so your trust does what you want and nothing slips through the cracks.

Step one: choose your assets

Before you get into the legal nitty-gritty, you’ll need to decide exactly what you’re putting into the trust. It could be cash, shares, a property, family business shares, or even a prized art collection.

Step two: create a trust deed

Next, you’ll need a legally binding trust deed – a document that sets out all the key details and rules for your discretionary trust. This isn’t one to DIY; you’ll want a solicitor to help, making sure everything’s watertight and HMRC-proof.

The trust deed will spell out exactly what’s being put into the trust (the assets), who’s in charge (the trustees), and the pool of people who could benefit (the beneficiaries).

With a discretionary trust, you don’t have to list every grandchild by name – you can simply say “my grandchildren,” and the trust will flex as your family grows.

The deed also covers things like when and how the trustees can make payments, and as we mentioned, usually includes a “letter of wishes” from you, explaining your preferences and intentions.

Step three: appoint trustees

Now it’s time to decide who’ll actually run your trust.

Remember, trustees are the ones with real control: they’ll manage the assets, make decisions, and ultimately decide who gets what and when. You can choose family members, friends, a professional firm – or a mix. Pick people you trust (the clue’s in the name), who are organised, level-headed, and likely to outlast you.

You can be a trustee yourself, at least while you’re still around, but it’s a good idea to appoint at least one other.

Remember, being a trustee is a serious responsibility – there’s legal and financial admin involved, and it’s not just a ceremonial role. Choose wisely and make sure everyone knows what’s expected.

Step four: transfer the assets

Once your trust deed is signed and your trustees are ready, it’s time to actually move your chosen assets into the trust.

This could mean transferring cash into a new bank account held by the trustees, shifting shares or investments into the trust’s name, or working with a solicitor to update the legal ownership of property.

Until the assets are officially transferred, your trust is just a nice idea on paper. Everything needs to be moved properly and documented – otherwise, HMRC (and your trustees) will say the trust doesn’t exist. 

If you’re transferring property, you’ll likely need a solicitor to handle the legal paperwork and update the Land Registry. For investments or shares, your provider or broker can help with the switch.

Double-check that every asset has made it across the finish line before you tick this step off your list.

Step five: register the trust

Last but definitely not least, most discretionary trusts need to be registered with HMRC’s Trust Registration Service. This step isn’t optional – thanks to anti-money laundering rules, it’s now a legal requirement for almost all new trusts (even if you don’t think there’ll be any tax to pay).

Registration means providing details about the trust, the assets, and everyone involved – including all trustees, the settlor, and any potential beneficiaries.

You’ve got 90 days from setting up the trust, so don’t leave it until the last minute.

If your solicitor or a professional trustee is handling things, they’ll usually take care of the registration – but it’s still your job to make sure it actually gets done.

Bottom line

Discretionary trusts aren’t just a playground for the super-rich or people with too much time on their hands – they’re a genuinely flexible tool for anyone who wants to keep their family wealth working in the right way, for the right people, at the right time.

They let you control who gets what (and when), protect your assets from the unexpected, and can help cut the tax bill – if you set them up properly.

But with that flexibility comes a bit more complexity: higher taxes, more paperwork, and decisions that shouldn’t be made lightly. For some, a bare trust or even a straightforward will might be a better fit.

If you’re thinking about setting up a trust, take your time, get expert advice, and make sure you’re clear on what you want to achieve. 

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