Discretionary Trusts Explained
Managing your wealth and making sure your loved ones are looked after is a big part of any financial planning journey. Whether you're thinking about protecting family assets, planning your estate, or providing for beneficiaries who may not be able to manage money themselves, understanding discretionary trusts is crucial.
This guide will take you step by step through the world of discretionary trusts in the UK—what they are, how they work, their pros and cons, and how you can set one up. If you want to take control of your financial legacy, read on.
What is a Discretionary Trust?
A discretionary trust is a legal arrangement where you (the settlor) give assets to trustees, who manage these assets for beneficiaries. What makes it “discretionary” is that the trustees have the power to decide:
Who receives funds from the trust (from a defined pool of beneficiaries)
When they receive them
How much they receive
This flexibility can help with inheritance tax planning, providing for vulnerable or young beneficiaries, and protecting family wealth.
Why Does a Discretionary Trust Matter in the UK?
In the UK, a discretionary trust offers:
Control over your assets even after you’re gone
Inheritance tax advantages if set up correctly
Protection for vulnerable or financially inexperienced beneficiaries
Potential ways to avoid “sideways disinheritance” (e.g., if your children’s family circumstances change)
How Does a Discretionary Trust Work?
Here’s a breakdown:
The Settlor: This is you – the person setting up the trust and transferring assets into it.
The Trustees: These are the individuals or professionals you appoint to manage the trust according to your instructions.
The Beneficiaries: These are the people or organisations who may benefit from the trust’s assets; often family members, children, or charities.
The trust is governed by a trust deed—a legal document outlining your wishes and the trustees’ powers. Beneficiaries do not have a fixed entitlement; instead, trustees use their discretion to make distributions.
Example
Let’s say you have three children. You set up a discretionary trust and name them as potential beneficiaries, but do not specify set amounts for each. The trustees can decide how much, if anything, each child gets and when—perhaps giving more to one who needs help with university fees or withholding for someone struggling with debts.
What Can You Put in a Discretionary Trust?
You can place a wide range of assets into a discretionary trust, including:
Cash or savings
Property or land
Life policies (often used for inheritance tax planning)
Transferring assets to a trust can have tax consequences, so professional advice is strongly recommended. Check the official guidance from GOV.UK: Trusts and taxes before you proceed.
Step-by-Step: How to Set Up a Discretionary Trust in the UK
1. Decide Why You Need a Discretionary Trust
Is it for managing inheritance tax (IHT)?
Protecting beneficiaries who are minors or have special needs?
Shielding assets from divorce or creditors?
2. Choose Your Trustees Carefully
Pick at least two trustees (you can appoint yourself, but consider a mix of family and professionals).
Trustees will control assets and have a legal duty to act in beneficiaries' best interests.
3. Draft the Trust Deed
This legal document spells out the trust’s terms, trustee powers, and who the beneficiaries are.
Use an experienced solicitor or a STEP-qualified professional.
4. Decide on Your Beneficiaries
These could be individuals (named or described as a group—e.g., “my grandchildren”) or charities.
5. Fund the Trust
Transfer assets such as cash, property, or investments into the trust. This may trigger inheritance or capital gains tax, so seek advice.
6. Register the Trust with HMRC
Almost all trusts must now be registered using the Trust Registration Service (TRS). There are deadlines for registration and penalties for non-compliance.
7. Set Out Your Wishes
You can write a “letter of wishes” to your trustees, giving guidance without making it legally binding.
8. Review Regularly
Circumstances change. Review your trust arrangement at least every few years.
Discretionary Trusts and Inheritance Tax
Inheritance tax (IHT) is one of the main reasons people use discretionary trusts. Here’s what you need to know:
Assets transferred to a discretionary trust are generally treated as a “chargeable lifetime transfer” for IHT purposes.
Transfers above the nil-rate band (£325,000 as of 2024) may attract a 20% IHT charge immediately.
Every 10 years, the trust may face a periodic “ten-year charge” of up to 6% on assets above the threshold.
Tip: Consider using your annual gift allowance, and seek tax advice to minimise trust IHT charges. The MoneyHelper Trusts Guide has more information.
Discretionary Trusts for Vulnerable and Disabled Beneficiaries
If you want to provide for someone who is disabled or otherwise vulnerable, a discretionary trust can help ensure they aren’t disqualified from means-tested benefits.
However, specialist advice is essential. Consider a “vulnerable person’s trust”, which has more favourable tax treatment.
Pros and Cons of Discretionary Trusts
Benefits
Flexible distributions: Trustees adapt to changing circumstances.
Asset protection: Estates shielded from beneficiaries’ divorces or bankruptcies.
Control: Assets are managed according to your wishes, even after death.
Inheritance Tax (IHT) planning: Part of wider IHT mitigation strategies.
Drawbacks
Complexity: Legal and tax rules are complicated.
Ongoing costs: Professional trustees and advisers may charge fees.
Taxation: Discretionary trusts are taxed at higher rates on income and capital gains than individuals.
Regular reviews required: Needs may change, so you can’t just “set and forget”.
Frequently Asked Questions
Q: Can I be a trustee and a beneficiary?
Yes, but you can’t be the only trustee and the only beneficiary. There must be more than one trustee and at least one other beneficiary.
Q: Are trusts public?
No, discretionary trusts are private arrangements and are not automatically made public, but must now be reported to HMRC and can be accessed by law enforcement.
Q: Can I change or revoke a discretionary trust?
It depends on the trust deed—some trusts are “revocable”, but most are set up so that you can’t reclaim assets after transfer. Professional advice is essential.
Conclusion: Is a Discretionary Trust Right for You?
Discretionary trusts are a powerful, flexible tool for UK estate planning. They offer control, protection, and the ability to provide for loved ones according to your wishes, even in complex family circumstances. But they also bring extra responsibilities, complexity, and potential tax implications.
If you think a discretionary trust could form part of your journey to financial security, start by reviewing your goals and getting trusted professional advice. With careful planning, this solution can help you safeguard your family’s future, whatever life brings.
