Discretionary Trusts and Inheritance Tax 2026/27: Complete Guide

What Is a Discretionary Trust?

A discretionary trust is a trust where the trustees have discretion over how and when to distribute income and capital among a defined class of potential beneficiaries, rather than any beneficiary having an automatic, fixed entitlement. This flexibility makes discretionary trusts popular for estate planning where the settlor wants to provide for a family over time while allowing trustees to respond to changing circumstances, such as a beneficiary's divorce, bankruptcy, or care needs.

Since 2006, most discretionary trusts fall within the "relevant property regime" for Inheritance Tax purposes, a specific set of rules that applies IHT charges at the point assets go into the trust, periodically while they remain in the trust, and again when assets are distributed out.

The Entry Charge

When assets are transferred into a discretionary trust during the settlor's lifetime, this is a "chargeable lifetime transfer" for Inheritance Tax purposes. If the value transferred, combined with any other chargeable transfers made in the preceding seven years, exceeds the settlor's available nil-rate band (£325,000 for 2026/27), an immediate entry charge of up to 20% applies to the excess.

Most transfers into trust that stay within the available nil-rate band incur no entry charge at all, which is why many trust-based estate planning strategies are carefully structured to work within, or just above, the nil-rate band threshold.

The Ten-Year Periodic Charge

Every ten years from the date the trust was created, trustees must calculate whether a periodic charge is due, based on the value of the trust's assets at that anniversary, less the nil-rate band available to the trust at that time (which can be reduced by other chargeable transfers the settlor made around the time the trust was set up). The maximum periodic charge rate is 6% of the value above the available nil-rate band, though in practice the effective rate is often lower once the specific calculation, which takes into account the trust's history, is applied.

Trustees are responsible for calculating and reporting the periodic charge to HMRC, typically via an IHT100 account, and this obligation applies even if the resulting charge turns out to be nil because the trust's value remains within the available nil-rate band.

The Exit Charge

When capital leaves the trust — for example, when trustees make a distribution of capital to a beneficiary — a proportionate exit charge can apply, calculated with reference to the rate of tax that applied at the trust's last ten-year anniversary (or the entry charge rate, if the exit happens before the first ten-year anniversary), and the time that has elapsed since that reference point.

Like the periodic charge, the exit charge is often nil in practice for smaller trusts that remain within the available nil-rate band, but the calculation must still be carried out and reported to confirm this, adding an ongoing compliance burden even where no tax is ultimately due.

Why Use a Discretionary Trust?

Despite the relevant property regime charges, discretionary trusts remain a valuable estate planning tool in several situations:

• Protecting vulnerable beneficiaries: Where a beneficiary cannot be trusted to manage a direct inheritance responsibly, or has a disability affecting their capacity to manage money
• Flexibility for future circumstances: Trustees can respond to a beneficiary's divorce, bankruptcy, or changing needs in a way a fixed inheritance cannot
• Controlling access across generations: Allowing assets to benefit children and grandchildren over time without giving any individual an outright, immediately accessible entitlement
• Life insurance policies written in trust: Ensuring proceeds fall outside the deceased's estate for IHT purposes while still being managed flexibly for named beneficiaries

Worked Example

Richard sets up a discretionary trust for his grandchildren, transferring £400,000 into it during his lifetime, having made no other chargeable transfers in the preceding seven years. Because this exceeds his £325,000 nil-rate band by £75,000, an immediate entry charge of up to 20% applies to that £75,000 excess.

Ten years later, the trust has grown to £480,000. At the periodic charge anniversary, trustees must calculate whether a periodic charge is due on the value above the nil-rate band available to the trust at that time, and report the position to HMRC even if the resulting rate, once the full calculation is applied, turns out to be modest.

Common Pitfalls

• Forgetting the seven-year cumulation rule. Other chargeable lifetime transfers in the preceding seven years reduce the nil-rate band available for a new trust transfer.
• Missing the ten-year reporting obligation. Trustees must calculate and report the periodic charge position even where no tax is ultimately due.
• Not reporting exit charges on distributions. Capital leaving the trust requires an exit charge calculation and, where relevant, reporting, regardless of how small the distribution.
• Assuming all trusts are treated identically. Trusts for disabled beneficiaries and certain other specific trust types can have different, sometimes more favourable, IHT treatment than a standard discretionary trust.
• Overlooking trustee income tax and CGT obligations. Beyond IHT, trustees generally need to file an SA900 trust and estate tax return covering trust income and capital gains each year.