A discretionary trust can remove assets from your estate for Inheritance Tax — but it is not a simple solution. It triggers an immediate IHT charge on transfer, faces a 10-year periodic charge, and requires ongoing administration. Here is exactly how it works, what it costs, and when it makes sense in 2026/27.
What Is a Discretionary Trust?
A discretionary trust has three key parties:
- Settlor — the person who creates the trust and transfers assets into it
- Trustees — the people who legally own and manage the assets (often family members, or a professional trustee)
- Beneficiaries — a class of people (e.g. “my children and their descendants”) who may benefit at the trustees’ discretion
No beneficiary has a fixed right to income or capital. The trustees decide who gets what and when. The settlor can provide a letter of wishes (not legally binding) to guide the trustees.
How Assets Into a Discretionary Trust Are Taxed
Unlike a simple gift to your children (which is a Potentially Exempt Transfer), putting assets into a discretionary trust is a Chargeable Lifetime Transfer (CLT). This means:
| Transfer value | Immediate IHT charge |
|---|---|
| Within your available nil-rate band (up to £325,000) | No immediate IHT |
| Above nil-rate band | 20% on the excess (half the death rate) |
If the settlor then dies within 7 years, an additional “clawback” charge applies — the full 40% rate less any 20% already paid.
The 14-year shadow
CLTs also “use up” the nil-rate band for PETs made in the following 7 years. If you put £325,000 into a trust and then make cash gifts to your children, those gifts have no nil-rate band protection for 7 years after the trust transfer.
The Trust’s Own IHT Charges
Once assets are in a discretionary trust, the trust faces its own ongoing IHT charges:
10-year periodic charge
Every 10 years, HMRC levies a charge on the trust’s assets:
- Rate: up to 6% of the value above the available nil-rate band
- The nil-rate band available to the trust may be reduced by any CLTs made in the 7 years before the trust was created
Example:
- Trust assets at 10-year anniversary: £700,000
- Nil-rate band: £325,000
- Chargeable amount: £375,000
- Periodic charge: £375,000 × 6% = £22,500
This charge repeats every 10 years, making the ongoing cost significant for large trusts.
Exit charges
When trustees distribute capital out of the trust (to beneficiaries), a proportional exit charge applies — calculated at a fraction of 6%, based on the time since the last periodic charge.
Example: Capital distributed 5 years after a periodic charge, when the periodic rate was 4.5%:
- Exit rate: 4.5% × (5/10) = 2.25%
- On £100,000 distributed: £2,250 exit charge
Worked Example: Robert’s Discretionary Trust
Robert, 65, has an estate worth £1.2 million. He wants to shelter £325,000 from IHT by putting it into a discretionary trust for his children and grandchildren.
Year 1: Transfer of £325,000 into trust
- Within nil-rate band: no immediate IHT
- Robert’s remaining NRB for other purposes: £0 for next 7 years
Year 10: 10-year periodic charge
- Trust assets grown to £500,000
- NRB available to trust: £325,000 (assuming no other CLTs)
- Chargeable: £175,000 × 6% = £10,500
If Robert dies within 7 years of the transfer:
- The £325,000 is added back to his estate
- Additional death rate IHT applies on any amount above nil-rate band remaining in his estate
- No taper relief applies to CLTs in the same way as PETs (the calculation is more complex)
When a Discretionary Trust Is Worth Considering
| Situation | Trust useful? |
|---|---|
| You want assets permanently out of your estate while retaining some indirect influence via letter of wishes | Yes |
| A beneficiary has debts, is in a difficult relationship, or cannot manage money | Yes — trustees protect the assets |
| You want to provide for a disabled or vulnerable family member without affecting their benefits | Yes — consider a disabled person’s trust specifically |
| You simply want to give money to your children | No — a direct gift (PET) is simpler and cheaper |
| You want to leave your home in trust | Possible, but specialist advice essential |
Costs and Administration
Discretionary trusts are not free:
- Legal costs to set up: typically £1,000–£3,000+
- Annual trustee administration: time and potentially professional fees
- Self-Assessment for the trust: income and gains are taxed within the trust at the trust rate (45% for income, 45% for gains above the trust annual exempt amount of £1,500)
- IHT return every 10 years and on exit distributions
- Reporting requirements under trust register rules (HMRC Trust Registration Service)
The tax complexity means most discretionary trusts need professional trustees or at least professional advice.
See our taper relief on IHT gifts guide, gifting property to children IHT guide, and pension inheritance tax 2027 changes.