Discretionary Trusts and Inheritance Tax: Could a Trust Help Protect Your Family’s Wealth?
You want to provide for your children and grandchildren while keeping flexibility, not handing over a single lump sum that could be spent in a flash. A discretionary trust is one tool that can help you manage who benefits, when and how much, without promising it is a simple tax fix. In this guide I explain in plain English what a discretionary trust is, how it works in the UK, the inheritance tax realities you must face in 2025/26 and the other tax traps to watch for. If you are a parent or grandparent thinking about passing on family wealth, you will find practical checklists, trustee selection tips and a sober assessment of pros and cons. Where I reference official tax procedures I link directly to HMRC guidance so you can check the detail for yourself, for example HMRC’s page on types of trust and their pages on trust IHT rules.
1. Could a trust help you pass on family wealth?
Many parents and grandparents feel a tug between generosity and prudence: you want to leave a meaningful legacy to children or grandchildren, but handing over a large sum outright can be worrying, especially if beneficiaries are young, inexperienced, or may need support at different times. A discretionary trust can offer flexibility by letting appointed trustees decide which named beneficiaries receive funds, and when. That flexibility can help you plan for education costs, a first-home deposit or unexpected care needs without writing a single cheque today. However, and I will be blunt, placing assets into a discretionary trust does not automatically remove them from inheritance tax consideration; discretionary trust inheritance tax rules are specific and can result in tax when you transfer assets, at periodic anniversary points and when assets leave the trust. Think of a discretionary trust as a tailored stewardship tool that may fit into a wider estate plan, rather than a simple route to tax-free passing on of family wealth.
A discretionary trust is a tool for stewardship and flexibility, not a short cut to tax-free inheritance; treated properly it can help you manage who benefits and when, while creating real responsibilities for trustees.
Jack Logan
2. What is a discretionary trust?
A discretionary trust is a legal arrangement where trustees hold and manage assets for a defined group of potential beneficiaries. The three key parties are the settlor, the trustees and the beneficiaries. The settlor is the person who creates the trust and transfers assets into it; the trustees are the legal owners who make decisions about investment, administration and distributions; beneficiaries are the people who may receive money or assets, but they do not ordinarily have an automatic right to a particular share. The trust deed will set the scope of the trustees’ powers and the class of beneficiaries; you can also write a letter of wishes to guide the trustees, though that letter is normally advisory rather than binding. For an official overview of trust types in the UK you can consult HMRC’s guidance on types of trust.
A discretionary trust lets trustees choose which beneficiaries receive funds and when, making it suitable for staggered support to children and grandchildren.
3. How does a discretionary trust work?
Creating and running a discretionary trust follows a series of clear steps. First, the settlor decides the purpose and which assets could be transferred. Second, a solicitor prepares the trust deed setting out trustee powers, beneficiary classes and any specific restrictions. Third, trustees are appointed and formally accept their responsibilities; trustees can be individuals, professionals or a mixture. Fourth, the settlor transfers assets into the trust, at which point legal ownership passes to the trustees. Fifth, trustees manage those assets in line with the deed and their fiduciary duties, including keeping records and meeting tax and reporting obligations. Sixth, trustees make discretionary distributions when and to whom they judge appropriate. Finally, the settlor may write a letter of wishes to guide trustees; that letter is generally advisory rather than a binding instruction and its exact legal effect should be confirmed with a solicitor. These steps show why professional legal and tax advice is normally needed before you move assets into a discretionary trust.
4. What assets can be placed in a discretionary trust?
You can place many asset types into a discretionary trust, including cash, investments and shares listed on UK or overseas exchanges, investment bonds, property or land, business interests and life assurance proceeds that are capable of assignment. Each category carries practical and tax implications. For example, transferring a UK residential property may require you to check mortgage terms, advise your lender and consider Stamp Duty Land Tax exposure; moving listed equities could trigger Capital Gains Tax if the transfer counts as a disposal for the settlor. Investment bonds may often be assigned to trustees, but the taxation of bond gains and adviser charges still needs regular review. Not every asset transfers neatly; some business shares carry restrictions, valuations can be contested and cross-border assets can bring complex residence and domicile questions. Before transferring, you should confirm the transferability, valuation method, any mortgage or lender consent rules and the immediate tax consequences.
Discretionary trust inheritance tax treatment commonly involves a chargeable lifetime transfer on entry, periodic ten-year charges and possible exit charges.
5. Why might someone consider a discretionary trust?
There are several reasons you might consider a discretionary trust when passing on family wealth. You may want to provide for children or grandchildren without giving any one person unrestricted control of a large lump sum; trustees can manage distributions to fund education, a first home or medical needs. A discretionary trust provides flexibility to respond to changing family circumstances, for example if one beneficiary needs help sooner than another, and it supports longer-term stewardship of family assets across generations. The arrangement can also help manage an inheritance for a beneficiary who lacks financial experience, and it allows you to document your intentions through a letter of wishes. If you have a vulnerable beneficiary, a discretionary trust can be tailored, but special trust and tax rules may apply and that should be treated as a distinct advice area. Remember, trustees must act within the trust deed and cannot use the fund for any purpose outside those powers.
6. Who controls the assets?
Control is one of the most important practical realities: trustees become the legal owners of trust assets, not the settlor. Trustees must follow the trust deed and their legal duties to look after beneficiaries’ interests, act impartially and manage investments prudently. A letter of wishes can guide trustees, but it does not give the settlor unrestricted control. If the settlor continues to use or benefit from an asset they have transferred, for example by living in a house they have placed into trust without proper arrangements, it can create tax complications and may invalidate intended tax treatments. The idea that you can ‘keep control while avoiding inheritance tax’ is a dangerous misconception; you give away legal ownership and the trust’s tax and legal position will depend on the nature of the transfer and any continuing benefit. Trustees must therefore be chosen and briefed carefully, and the deed and wishes kept under regular review.
Because of IHT, CGT and income tax interactions, legal, tax and financial planning advice is essential before you transfer assets into a trust.
7. How are discretionary trusts treated for Inheritance Tax?
Discretionary trusts usually fall under the relevant property regime for inheritance tax, meaning IHT may arise at three distinct points: when assets enter the trust, at ten-year anniversary points and when assets leave the trust. First, a lifetime transfer into a discretionary trust is typically a chargeable lifetime transfer, CLT, not a potentially exempt transfer, PET. A CLT may trigger IHT where the value transferred, together with previous chargeable transfers in the prior seven years, exceeds the available nil-rate band for the tax year 2025/26; the calculation depends on the amount transferred, the dates of previous transfers, available exemptions and whether the settlor or trustees pay the tax, among other factors. Second, discretionary trusts face a ten-year anniversary charge on the net value of relevant property, subject to historic calculations and thresholds. Third, an exit charge may apply when capital leaves the trust; the amount depends on how long assets have been held, prior ten-year charges, the value distributed and the trust’s history. For the technical rules on ten-year and exit assessments see HMRC’s guidance on trusts and Inheritance Tax and check nil-rate band levels for 2025/26 before you act.
8. Other taxes that may apply
Inheritance tax is only one of the tax considerations when you use a discretionary trust. Capital Gains Tax can apply because transferring an asset into a trust may count as a disposal for the settlor; trustees also face CGT when they sell or dispose of trust assets, and trustees have their own annual exempt amount. Hold-over relief can sometimes defer a gain, but it is not universally available. Income generated by trust assets is taxed under the trust income rules, and trustees are generally responsible for reporting and paying tax; beneficiaries may have reclaim or reporting considerations if income is distributed. Transferring property or land can trigger Stamp Duty Land Tax and require lender consent and legal work. Most trusts must also be registered with HMRC’s Trust Registration Service and comply with reporting rules; see HMRC on trusts and Capital Gains Tax, trusts and Income Tax and registering a trust.
9. Advantages of a discretionary trust
A discretionary trust offers several potential advantages you should weigh carefully. First, flexibility, because trustees can choose which beneficiaries to assist and how much each receives; second, responsiveness, as trustees can react to changing family needs over time; third, stewardship for young or inexperienced beneficiaries, ensuring funds are managed until someone is ready; fourth, the ability to document your intentions with a letter of wishes; fifth, separation of legal ownership from potential benefit so assets are professionally managed if required; sixth, the potential to plan for multi-generational succession and continuity; and seventh, the chance to coordinate distributions with wider estate planning, pensions and wills. These advantages are conditional and depend on trustee quality, the trust deed and careful tax planning, so treat them as likely benefits rather than guaranteed outcomes. Where investment management is important, trustees may need professional portfolio management and you can learn more about managing investments at our portfolio management page.
10. Disadvantages of a discretionary trust
A discretionary trust also brings clear disadvantages and obligations that you must accept. First, the settlor gives up legal ownership of transferred assets; second, trustees face significant legal and administrative responsibilities including record keeping and tax reporting; third, tax can arise when assets enter the trust, at ten-year anniversaries and when assets leave the trust; fourth, trust tax rates and allowances can be less favourable than personal taxation; fifth, legal, investment, accounting and tax-advice costs may apply; sixth, trustees may need to file tax returns and arrange valuations; seventh, Trust Registration Service obligations apply; eighth, trustee decisions may disappoint beneficiaries and create family tension; ninth, the arrangement can be hard or costly to change later; tenth, a trust can endure for many years and require ongoing management; and eleventh, transferring assets without checking immediate tax consequences is a common costly error. Trustees’ duties are set out clearly by HMRC and government guidance on trustee responsibilities is a useful reference here.
11. Choosing trustees
Choosing the right trustees is arguably as important as deciding to create a discretionary trust. Good trustees are trustworthy, financially responsible, able to act impartially, willing to understand their duties and likely to remain available over the long term; they must also be capable of handling difficult family decisions and record keeping. You can appoint family members, trusted friends, solicitors, accountants, professional or corporate trustees, or a combination. Appointing family avoids fees but does not remove the need for professional advice, and family trustees may struggle with impartiality in difficult situations. Many families choose a mix of personal and professional trustees to balance personal knowledge with continuity and technical competence. Whatever you decide, it is crucial to explain responsibilities to trustees in advance and to budget for professional support where necessary.
12. Discretionary trust versus making an outright gift
Deciding between a discretionary trust and an outright gift depends on your priorities. An outright gift gives the recipient immediate legal ownership and control, and may suit a straightforward transfer to a capable adult. A discretionary trust, by contrast, places legal ownership with trustees and gives them discretion over distributions; it suits situations where you want managed access, flexibility or stewardship. The tax treatment differs: discretionary trust transfers are typically CLTs subject to the relevant property regime, while gifts to individuals may be potentially exempt transfers in certain cases. Administration and ongoing costs are higher for trusts, and trustee decisions can create tension if expectations are not managed. Neither option is universally better; the right choice depends on family circumstances, the type of asset, your desire for control and your appetite for administrative complexity.
13. Discretionary trust versus a trust created by a will
You can create a discretionary trust during your lifetime, or include discretionary provisions in your will so the trust arises on your death. A lifetime trust involves transferring assets while you are alive and triggers immediate legal, tax and practical considerations; a will trust comes into effect after death and forms part of the estate administration process. The timing affects inheritance tax treatment, valuation points and practical control while you are alive. Importantly, a will containing a discretionary trust provision does not automatically reduce Inheritance Tax on the estate; estate-wide calculations and thresholds still apply. Choosing between a lifetime discretionary trust and a will trust depends on whether you want the trust to begin immediately, how you wish to use nil-rate and residence nil-rate band allowances in force for 2025/26, and the operational complexities of running a trust while you are alive versus after death. Specialist legal advice is essential for that choice.
14. Common mistakes
People often make avoidable errors when creating discretionary trusts. Common mistakes include treating a trust as an automatic inheritance tax loophole; assuming a transfer becomes tax-free after surviving seven years; putting assets into trust without calculating the immediate tax consequences; believing the settlor can continue using assets as before after transferring them; choosing trustees without explaining their responsibilities; failing to keep the trust deed and letter of wishes under review; ignoring income tax and capital gains tax implications; forgetting ten-year and exit-charge obligations; failing to register or report the trust where required; transferring property without checking mortgage and legal implications; creating multiple trusts without understanding interactions; using an unsuitable standard or online trust document; and failing to coordinate the trust with your will, pension nominations and wider estate plan. Avoiding these mistakes usually requires coordinated legal, tax and financial advice before you act.
15. A practical checklist before establishing a trust
Before you establish a discretionary trust, run through a practical checklist: 1) Define what you want the trust to achieve and write your objectives; 2) Identify the intended beneficiaries and consider alternative classes; 3) Decide which assets might be transferred and confirm their transferability; 4) Assess what assets you still need for your own lifetime and cashflow; 5) Understand that legal ownership will pass to trustees; 6) Review the immediate Inheritance Tax and Capital Gains Tax position for 2025/26; 7) Consider future income tax, ten-year and exit charges under the relevant property regime; 8) Choose suitable trustees and explain their responsibilities; 9) Consider how trustees will make investment and distribution decisions and whether they need professional support; 10) Consider preparing a letter of wishes for trustees; 11) Review the trust alongside your will, pensions and wider estate plan; and 12) Obtain legal, tax and financial planning advice before making any transfers. This checklist helps you avoid rushed decisions that can be costly and hard to reverse.
16. When might professional advice be useful?
Seek professional legal, tax and financial planning advice in specific circumstances: when the proposed transfer is substantial; if property, business interests or complex investments are involved; if you have made previous lifetime gifts; if several trusts already exist; if family members include vulnerable or financially inexperienced beneficiaries; if you wish to retain access to or use of an asset; if you or beneficiaries live overseas; if you have recently moved into or out of the UK; if agricultural or business property is involved; if family relationships or distributions are complicated; or if the trust will form part of a broader succession strategy. A discretionary trust can provide valuable flexibility, but it introduces legal responsibilities, tax considerations and ongoing administration. If you are considering using a trust to pass wealth to children, grandchildren or other beneficiaries, professional legal, tax and financial planning advice can help you understand whether it is appropriate for your family and how it would fit into your wider estate plan. About the author: Jack Logan is an Independent Financial Adviser at Humboldt Financial, you can view his profile at Jack Logan.
About the author
Jack Logan is an Independent Financial Adviser at Humboldt Financial. He specialises in tax-aware retirement and estate planning for families. For his full profile and contact details, please visit Jack Logan.
Discretionary Trust versus Outright Gift
| Consideration | Discretionary trust | Outright gift |
|---|---|---|
| Ownership | Trustees legally hold the assets | Recipient owns the assets |
| Access | Determined by trustees and the deed | Recipient normally has immediate control |
| Flexibility | Trustees may choose between beneficiaries | Gift is made to a specified person |
| Administration | Ongoing trust administration required | Usually simpler after the gift |
| Tax | Trust tax regime (CLT, ten-year, exit charges) applies | Different gift and personal tax rules apply |
| Control | Settlor gives legal control to trustees | Donor gives control directly to the recipient |
| Suitability | May help where flexibility or managed access is important | May suit straightforward gifts to capable adults |
Frequently Asked Questions
What is a discretionary trust?
A discretionary trust is a legal arrangement where appointed trustees hold assets for a defined class of potential beneficiaries and decide, at their discretion, who receives money or assets and when. The settlor creates the trust and transfers assets, trustees become legal owners with fiduciary duties, and beneficiaries have a potential but not an automatic entitlement. A letter of wishes can guide trustees but is generally advisory, and the trust deed governs legal powers and limitations.
How does a discretionary trust work in the UK?
In the UK a discretionary trust is set up by a trust deed prepared by a solicitor, trustees accept their role, and assets are transferred into the trust. Trustees manage investments and make distributions in line with the deed and legal duties. The trust must usually be registered with HMRC’s Trust Registration Service and trustees handle tax reporting. A discretionary trust often falls under the relevant property regime for Inheritance Tax, with specific entry, ten-year and exit charge mechanics.
Does a discretionary trust avoid Inheritance Tax?
No, a discretionary trust does not automatically avoid inheritance tax. Transfers into a discretionary trust are commonly chargeable lifetime transfers and may be subject to IHT if the value transferred plus prior chargeable transfers exceeds the available nil-rate band for the relevant tax year. The trust may also face ten-year anniversary charges and exit charges when assets are distributed. Always treat discretionary trust inheritance tax as a complex set of potential charges rather than a simple avoidance route.
Is there Inheritance Tax when assets enter a trust?
Yes, transfers into a discretionary trust are usually treated as chargeable lifetime transfers, CLTs, not PETs. IHT may be payable on entry where the transferred value, together with other chargeable transfers in the prior seven years, exceeds the available nil-rate band for the tax year 2025/26. The exact amount depends on prior transfers, when they were made, whether the settlor or trustees pay tax, and other exemptions and reliefs; check HMRC thresholds and take professional advice before transferring.
What is the seven-year rule for a discretionary trust?
For discretionary trusts the seven-year concept differs from outright gifts. Transfers into discretionary trusts are CLTs; surviving seven years does not make the transfer automatically tax-free from the outset. If the settlor dies within seven years, the transfer may be brought back into account when calculating the estate’s IHT position, and earlier chargeable transfers in the seven-year window can affect the calculation. The interaction with nil-rate bands and other gifts is complex, so seek specialist advice if death occurs within seven years of a transfer.
What is the ten-year charge on a discretionary trust?
Under the relevant property regime, discretionary trusts typically face a periodic IHT charge on each ten-year anniversary of creation. The ten-year charge applies to the net value of relevant property held immediately before the anniversary, subject to reliefs, previous charges and thresholds. The calculation takes into account earlier transfers and other trusts created by the settlor; it is not a simple flat-rate tax on the whole fund. Trustees should plan for valuation and tax compliance around anticipated anniversary dates.
What is an exit charge?
An exit charge, sometimes called a proportionate charge, may arise when relevant property leaves the trust, such as when capital is distributed to a beneficiary. The amount depends on how long the assets have been held, the value distributed, the rate established at the last ten-year anniversary, and the trust’s historical tax position. Trustees should assess potential exit charges before authorising distributions, as timing and previous ten-year charges materially affect the tax due.
Who controls the assets in a discretionary trust?
Trustees control the assets. Once you transfer property into a discretionary trust the trustees become the legal owners and must act within the trust deed and their fiduciary duties. The settlor normally cannot continue to treat the assets as personally owned. A letter of wishes may influence trustee decisions but does not confer legal control. Retaining personal use or benefit after transfer may create tax and legal complications.
Can a settlor also be a trustee?
A settlor can be appointed as a trustee in some circumstances, but this raises practical and tax considerations and must be handled carefully. Where the settlor is a trustee and continues to benefit directly from trust assets the arrangement may trigger gifts with reservation rules or other tax issues. Whether this is appropriate depends on the trust’s purpose, the deed wording and the settlor’s objectives; always take legal and tax advice before combining roles.
Can a settlor benefit from their own discretionary trust?
A settlor can be named as a potential beneficiary in some trust structures, but if the settlor continues to derive benefit from assets they put into the trust, for example by living in a house they have transferred, it can create gifts with reservation problems and affect the intended tax treatment. The permissibility and consequences depend on deed wording and the specific facts, so professional legal and tax advice is essential before allowing a settlor to benefit.
What taxes do discretionary trusts pay?
Discretionary trusts may face three categories of tax: Inheritance Tax under the relevant property regime at entry, on ten-year anniversaries and on exits; Capital Gains Tax when assets are transferred into or disposed of by the trust, subject to trustees’ CGT rules and exemptions; and Income Tax on income generated by trust assets, reported and paid by trustees under trust income tax rules. Stamp taxes and land taxes may also apply on property transfers, and most trusts must register with HMRC’s Trust Registration Service.
Can property be placed into a discretionary trust?
Yes, property can be placed into a discretionary trust, including UK residential land, but this can create additional complications: mortgage lender consent may be required, Stamp Duty Land Tax or other conveyancing costs may apply, and transferring property can trigger Capital Gains Tax if the transfer counts as a disposal. If you intend to place a family home into trust while continuing to live there, that raises specific gifts with reservation and tax issues which need careful legal and tax planning.
Does a discretionary trust need to be registered with HMRC?
Most UK trusts must be registered with HMRC’s Trust Registration Service. Trustees should check the Trust Registration Service requirements and ensure timely registration and reporting; failure to register can result in penalties. Registration obligations vary depending on the trust type and whether the trust has a UK tax liability, so trustees should confirm whether registration is required and keep records up to date.
What are the disadvantages of a discretionary trust?
Disadvantages include giving up legal ownership, trustee responsibilities and ongoing administration, possible IHT on entry, ten-year and exit charges, less favourable tax rates and allowances compared with personal taxation, professional fees for legal and accounting work, potential family disagreement over trustee decisions, and limited flexibility to change the arrangement later. These downsides mean a discretionary trust is most suitable where flexibility and stewardship outweigh cost and complexity.
Ready to explore whether a discretionary trust could suit your family?
If you are considering a discretionary trust as part of your estate planning, arrange a conversation with a qualified financial adviser and solicitor who can model the tax implications and draft a trust deed that reflects your family’s needs. For coordinated advice on tax-aware planning, investment management and estate administration, we can help you start the process.
Speak to an adviserSources
- HMRC – types of trust – Official guidance on different trust categories and their legal characteristics.
- HMRC – trusts and Inheritance Tax – Rules covering CLTs, ten-year charges and exit charges for relevant property trusts.
- HMRC – trusts and Capital Gains Tax – CGT treatment for transfers to and disposals by trusts.
- HMRC – trusts and Income Tax – Income tax reporting and liability rules for trustees and discretionary trusts.
- HMRC – registering a trust – Guidance on the Trust Registration Service and trustee registration obligations.
- HMRC – trustee responsibilities – Summary of trustee duties, record keeping and tax reporting expectations.
Final Thoughts
A discretionary trust can be a powerful tool for passing on family wealth in a measured, flexible way that supports children and grandchildren at the times they need help most. It permits trustees to manage assets, to make targeted distributions for education, a first home or unforeseen needs, and to steward capital across generations. But it also demands clarity about control, a full awareness of discretionary trust inheritance tax mechanics and other taxes, and a willingness to accept ongoing administration and trustee duties. If you are considering this route, take time to map objectives, identify appropriate trustees and secure coordinated legal, tax and financial advice. This article is for general information purposes only and does not constitute personalised financial, tax or legal advice. Tax treatment depends on your individual circumstances and may change. You should seek regulated advice from a qualified financial adviser, solicitor and tax professional before making any decisions about trusts or estate planning.
