Setting Up Discretionary Trust

What Is a Discretionary Trust?

A discretionary trust is a legal arrangement where assets are transferred to trustees, who manage them for the benefit of a group of beneficiaries. Unlike other types of trusts, beneficiaries do not have a fixed entitlement to the assets and have no automatic right to receive trust funds unless the trustees decide to distribute them. Instead, the trustees have discretionary powers over:

Who receives money or support
How much they receive
When payments are made

A key feature of discretionary trusts is the flexibility trustees have in making decisions about distributions.

This makes discretionary trusts ideal for families who need flexibility or wish to protect assets from future risks. In practice, discretionary trusts work by allowing trustees to use their discretionary powers to decide how and when to distribute trust income or capital to beneficiaries, based on changing circumstances.

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Why Consider a Discretionary Trust?

Discretionary trusts are used widely across the UK for several important reasons. The benefits of discretionary trusts include flexibility in asset distribution, tax planning opportunities, and asset protection for estate planning and management.

One of the main reasons people set up discretionary trusts is to protect assets from risks such as creditors, divorce, or other financial threats. By placing assets in a trust, you can ensure they are managed and distributed according to your wishes, rather than being exposed to potential claims.

Discretionary trusts are also useful for safeguarding assets for beneficiaries who may be vulnerable, such as those with addictions, disabilities, or a history of making poor life choices. This allows trustees to manage and allocate funds responsibly, helping to prevent misuse or squandering of the inheritance.

Protecting Family Wealth

Trusts help shield assets from divorce settlements, bankruptcy, or poor financial decision-making by beneficiaries.

Supporting Vulnerable or Young Beneficiaries

If a child, vulnerable adult, or someone with special needs is involved, a trust ensures their inheritance is managed responsibly.

Tax Planning Opportunities

A discretionary trust can be structured in a tax-efficient way by considering specific thresholds that impact tax exposure, helping reduce inheritance tax exposure and long-term liabilities.

It is essential to stay informed about current tax laws when structuring a discretionary trust to ensure compliance and maximize available tax reliefs.

Flexibility in Changing Circumstances

Trustees can adapt decisions based on personal, health, or financial changes within the family.

Long-Term Control and Safeguarding

You can decide how wealth is used over many years—even after you are no longer here, for example by setting up a trust fund to ensure your assets are managed and preserved according to your wishes.

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What Can Be Placed in a Discretionary Trust?

A broad range of assets can be placed inside a trust, including:

Property
Cash and savings
Investments and shares
Business interests
Life insurance pay-outs

The assets transferred into the trust may have tax implications, and some transfers may be considered chargeable gifts for inheritance tax purposes. Trust assets must be carefully selected and managed to meet the trust’s objectives.

Your estate planning specialist can advise which assets are most suitable, how to transfer them correctly, and how to ensure family members are properly named as beneficiaries of discretionary trusts.

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How to Set Up a Discretionary Trust?

Setting up a discretionary trust must be done carefully to ensure compliance with UK law. When establishing a trust, it is important to address key areas such as selecting appropriate assets, identifying beneficiaries, appointing trustees, and considering all legal requirements. Here’s how the process works:

1. Define Your Objectives

Before anything else, clarify:

Who the potential beneficiaries will be
How flexible you want the trust to be
What type of assets will be included
Your long-term goals (e.g., protecting children, managing tax, estate preservation)

2. Choose Your Trustees

Trustees should be people (or professionals) you trust completely. They will have significant authority over how and when assets are distributed.

It’s recommended to appoint:

At least two trustees
A professional trustee for added expertise and continuity

3. Draft the Trust Deed

This legal document outlines:

Who the trustees are
Who the beneficiaries may be
What powers the trustees hold
Any guidance or restrictions you want to include

A estate planning specialist should prepare the deed to ensure it is legally sound.

4. Create a Letter of Wishes (Optional but Highly Recommended)

This non-binding document guides trustees on how you would like the trust to be managed. It can include:

Your priorities
Preferred beneficiaries
How money should ideally be used

Because it’s flexible, it can be updated at any time.

5. Transfer Assets to the Trust

This step is known as “settling” the trust, and involves the assets transferred into the trust. When assets are transferred, a tax charge may apply, particularly if the value of the assets exceeds the inheritance tax threshold. If the settlor dies within seven years of making a gift into the trust, additional inheritance tax charges may arise, and taper relief could reduce the tax burden. Discretionary trusts are also subject to a periodic charge every 10 years, which is calculated on the value of the trust assets above the nil rate band. All transfers and charges must be carefully considered for IHT purposes.

It may trigger tax considerations, including:

Inheritance Tax
Income Tax
Capital Gains Tax

Professional advice ensures these are handled correctly.

6. Register the Trust with HMRC

Most discretionary trusts must be registered with HM Revenue & Customs (HMRC) on the Trust Registration Service (TRS). Failure to register can result in penalties.

What Are the Tax Implications?

Discretionary trusts can be highly tax-efficient, but they do have unique tax rules. Both trust assets and trust income are taxed under specific rules, including inheritance tax, capital gains tax, and income tax. Trust income is managed and taxed separately from personal income, and trustees must ensure correct tax payments are made according to the relevant regulations.

Inheritance Tax (IHT)

Potential 20% entry charge on assets over the nil-rate band. The value of the settlor’s estate is taken into account when calculating inheritance tax charges, as transferring assets into the trust can reduce the settlor’s estate and affect overall tax liabilities.
Possible 10-year (periodic) charges
Exit charges when assets leave the trust

Income & Capital Gains Tax

Trustees may pay at higher rates on both the income and capital gains generated by the trust.
Beneficiaries may reclaim some tax depending on their individual circumstances

A qualified trust specialist will help structure the trust in the most tax-effective way.

Why You Need Professional Support

Discretionary trusts are powerful but complex. An expert will help you:

Avoid common legal and tax pitfalls
Ensure the trust is set up correctly
Choose suitable trustees
Plan the trust in alignment with your wider estate
Register and administer the trust in line with UK regulations

Trustees have a fiduciary duty to manage the trust in the best interests of the beneficiaries. They must act in accordance with the trust deed and all relevant legal requirements. It is also important for trustees to regularly review the trust’s performance to ensure it continues to meet its objectives.

Trying to set up a trust without guidance can lead to invalid documents, unexpected taxes, or even disputes later on.

Get Expert Help Setting Up a Discretionary Trust

If you’re considering placing assets into a discretionary trust, professional estate-planning guidance is essential. We can help you:

Understand your options
Draft and execute the trust
Create tax-efficient strategies
Protect your family and future generations