How is a discretionary will trust taxed for Inheritance Tax in the UK?

Full answer

A discretionary will trust is created by a will and comes into existence on the testator's death. The trustees hold assets on behalf of a class of beneficiaries (e.g., children, grandchildren) but have discretion over who receives what and when. IHT on death (entry charge) Assets passing into the trust from the estate are subject to IHT as part of the deceased's estate at the normal 40% rate (above the available nil-rate band of GBP 325,000 plus any unused residential nil-rate band). If the estate is below the IHT threshold (or reliefs such as BPR/APR apply), no IHT is charged on entry to the trust. There is no additional IHT entry charge for assets entering a discretionary will trust from death (unlike lifetime gifts into trust which are Chargeable Lifetime Transfers with a 20% lifetime rate and potential 40% death tax on top if the donor dies within 7 years). Periodic (10-year) charge Every 10 years after the trust is set up, HMRC charges a periodic charge of up to 6% on the value of the trust fund above the available nil-rate band at the time. The calculation is complex -- it involves the original chargeable value, any CLTs made by the settlor in the 7 years before the trust was created, and any distributions made since the last periodic charge. Effective rate: 30% of the lifetime rate of 20% = 6% maximum on the excess over NRB. Exit charge When the trustees distribute assets or a beneficiary becomes absolutely entitled, an exit charge applies. The rate is a proportion of the periodic charge rate, based on how much of the 10-year period has elapsed since the last periodic charge (or since the trust was created). Income tax within the trust Discretionary trusts pay income tax at the trust rate: -- 45% on non-dividend income above GBP 1,000 Standard Rate Band -- 39.35% on dividend income above GBP 1,000 -- Within the SRB: 20% (non-dividend) / 8.75% (dividend) When income is paid to beneficiaries, it carries a 45% tax credit. Beneficiaries can reclaim the difference if they are non-taxpayers or basic-rate taxpayers. CGT within the trust Trustees pay CGT at 24% (residential property) or 20% (other assets). There is no CGT uplift on the death of the settlor (unlike assets inherited directly by an individual where the base cost is uplifted to market value at death). The trust has an annual exempt amount of GBP 1,500 (one-half of individual AEA) in 2026/27. Uses of discretionary will trusts Flexibility for the trustees to respond to changed circumstances; asset protection from beneficiary creditors or divorce; useful where the testator is unsure which beneficiaries should benefit and when.

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