A discretionary trust is taxed at three points: on the way in, periodically while it exists, and on the way out. The regime is deliberately unattractive — you are paying for control and flexibility.
A discretionary trust separates the ownership of assets from the entitlement to them. Trustees hold the property and decide, within the terms of the trust, which of a class of beneficiaries receives what and when. Nobody has a fixed right to anything, which is the source of both the flexibility and the tax treatment.
People use them for reasons that are mostly not about tax: protecting assets for children who are too young or too vulnerable to receive them outright, keeping value out of a divorce or a bankruptcy, providing for a second family alongside children from a first, or retaining flexibility where circumstances may change over decades. The tax regime is the price of that, and it is not a small one.
The Three Inheritance Tax Charges
| Charge | When | What it is for |
|---|---|---|
| Entry | On putting assets in | A lifetime chargeable transfer, subject to available nil rate band |
| Periodic | At ten-yearly intervals | Substitute for the charge that would arise on a death |
| Exit | When property leaves the trust | Proportionate charge for the period since the last ten-year point |
The logic is that assets in a discretionary trust belong to nobody in particular and would otherwise escape inheritance tax indefinitely, so the regime imposes charges at intervals instead. The rates and the mechanics of each charge are specific and this site does not publish them; a solicitor or accountant who does trust work is the right source, and this is not an area to work from general reading.
The ten-year cycle is administrative as well as fiscal. Trustees have reporting obligations at each anniversary whether or not tax is due, and trusts also have their own registration requirements. Trusts that were set up and then forgotten about accumulate compliance failures quietly.
Income and Gains Inside the Trust
- Income arising in a discretionary trust is taxed at trust rates, which are set at the top of the personal scale, with a small standard rate band before they apply.
- Distributions to beneficiaries carry a tax credit, so a beneficiary taxed below the trust rate can reclaim the difference — which is a real benefit for a beneficiary with little other income.
- Capital gains are taxed on the trustees, with an annual exemption lower than an individual's.
- Administration costs are real: accounts, returns, and professional trustee fees where used.
The practical consequence is that trusts holding income-producing assets are expensive to run and trusts holding growth assets are less so. That shapes what actually goes into them.
Who They Suit
- Families with minor children, where outright inheritance at eighteen is undesirable.
- Vulnerable beneficiaries, where specific regimes can apply more favourable treatment.
- Blended families, providing for a surviving spouse while preserving capital for children of an earlier marriage.
- Business owners, particularly where reliefs on business or agricultural property affect the entry charge.
- Anyone wanting flexibility over decades, where fixed shares set today would be wrong in twenty years.
Who They Do Not Suit
Anyone whose primary aim is reducing tax on a straightforward estate is usually better served by simpler routes: full use of nil rate bands between spouses, lifetime gifting, pension nominations, and the reliefs that apply to a main residence. A trust adds cost and complexity permanently, and it is a poor answer to a problem that a well-drafted will solves. Our guide to inheritance tax covers the estate position, and family investment companies covers the corporate alternative that some families use instead.
Trusts and Living Abroad
Adding an international element multiplies the complexity rather than adding to it. Trustee residence, settlor residence, beneficiary residence and the location of assets all matter, and many countries have no concept of a trust at all — some treat them as transparent, some as companies, some as nothing. A UK trust can be an expensive thing to own or benefit from once you live elsewhere. Anyone in that position should read wills and succession abroad and take advice in both jurisdictions.
Frequently Asked Questions
Why are discretionary trusts taxed so heavily?
Because assets in them belong to nobody in particular and would otherwise escape inheritance tax indefinitely. The entry, ten-yearly and exit charges substitute for the charge that would arise on a death.
Can a beneficiary reclaim tax on a distribution?
Often, yes. Distributions carry a tax credit reflecting the trust rate, so a beneficiary whose own rate is lower can reclaim the difference. That is a genuine benefit for beneficiaries with little other income.
Are trusts a good way to reduce inheritance tax?
Rarely as a primary aim on a straightforward estate. Nil rate bands between spouses, lifetime gifting and pension nominations usually achieve more at far lower cost and complexity.
What do trustees have to do every ten years?
Report and, where due, pay the periodic charge. The obligation exists whether or not tax is payable, and trusts also carry registration requirements that are easy to overlook.
Related Guides
Keep reading with these related guides and calculators:
- Family investment companies — the corporate alternative
- Deeds of variation — redirecting after a death
- Inheritance tax — the estate position
- Wills and succession — the international dimension
- How wealth is structured — where trusts sit
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