What Is a Discretionary Trust—An Estate Planning Guide for UK Expats

In this guide, we’ll provide a comprehensive overview of discretionary trusts, outlining their purpose, structure, and key benefits for estate and tax planning. We’ll also detail the essential steps involved in setting up a discretionary trust.

What Is a Discretionary Trust?

A discretionary trust is a legal arrangement in which the settlor grants the trustee complete discretion over how, when, and to whom the trust assets are distributed. While the trustee is granted broad authority, they are also bound by fiduciary duties and must manage the trust in accordance with its terms and the best interests of the beneficiaries.

Unlike fixed trusts, where beneficiaries have defined entitlements to trust assets, a discretionary trust does not grant beneficiaries any guaranteed rights to income or capital.

However, the trust deed may name “default” or “appointee” beneficiaries who become entitled if the trustees do not exercise their discretion within a specified period. Discretionary trusts are often employed for estate and inheritance tax planning, as they offer a flexible and potentially tax-efficient way of transferring wealth across generations. This flexibility makes discretionary trusts particularly beneficial when the settlor seeks to retain control over wealth distribution or when the future needs and circumstances of beneficiaries are uncertain.

Types of Discretionary Trusts

Discretionary trusts can be designed to meet distinct estate planning, philanthropic, or family wealth objectives. The structure depends on the settlor’s priorities, but the most commonly established types are:

Who Is Involved in a Discretionary Trust?

A discretionary trust involves three parties, each with a specific role:

1. Settlor
2. Trustees
3. Beneficiaries

Settlor

The settlor is the person who establishes the trust by transferring specified assets—such as investments, property, or cash—into the trust. Transferring UK registered pension benefits directly into a private trust is generally not permitted and may have adverse tax consequences; however, separate “bypass” or death benefit trusts can sometimes be used alongside pension arrangements.

Once this transfer is completed, the settlor relinquishes legal ownership and direct control over the assets in favour of the trustees, as defined in the trust deed.

The settlor is the person who establishes the trust by transferring specified assets—such as investments, property, pension benefits, or cash—into the trust. Once this transfer is completed, the settlor relinquishes legal ownership and direct control over the assets in favour of the trustees, as defined in the trust deed.

The settlor appoints the initial trustees, defines the class of potential beneficiaries, and may issue a non-binding letter of wishes to guide trust administration. While not legally enforceable, a letter of wishes serves to communicate the settlor’s intentions and offers guidance to the trustees in their decision-making.

A discretionary trust may have more than one settlor, particularly in arrangements involving jointly held assets. For instance, two individuals may act as settlors in relation to a joint life insurance policy or co-owned property.

Trustees

Discretionary trust trustees are the legal custodians of the trust assets, appointed by the settlor to manage and administer the discretionary trust fund in accordance with the trust deed and applicable laws.

Trustees are granted discretionary authority to determine which beneficiaries receive distributions, in what amounts, and at what times. Trustees may be individuals, professionals, or corporate entities, and a well-structured trust often includes mechanisms to replace or appoint new trustees as necessary.

Trustees also have reporting and registration obligations under the UK Trust Registration Service (TRS) where the trust has a UK connection or relevant UK assets.

Beneficiaries

While not entitled to any part of the trust fund directly, discretionary trust beneficiaries are individuals and organisations that may benefit from the trust. Persons who may be designated as beneficiaries include:

• The settlor’s spouse or civil partner
• The settlor’s children, grandchildren, and their spouses or civil partners
• Extended family members descended from the settlor’s parents, including their spouses or civil partners
• Individuals entitled to benefit under the settlor’s residuary estate
• Specifically named individuals, such as cohabitees or close family friends
• Charitable organisations or other entities identified in a deed of addition

Furthermore, beneficiaries may be broadly divided into two types:

• Discretionary (or potential) beneficiaries
• Default (or named) beneficiaries

Discretionary beneficiaries are members of a broader class defined in the trust deed. They do not hold any fixed entitlement to income or capital, nor are they assigned specific shares. The trustees retain complete discretion over distributions to individuals within the designated class and are not obligated to treat all beneficiaries equally or make distributions to every member of the class.

By contrast, default beneficiaries are specifically named in the trust documentation. They typically serve as a safety mechanism and are entitled to receive any remaining trust assets at the end of the trust period if no prior distributions have been made.

Whether default beneficiaries have a contingent entitlement depends entirely on the terms of the trust deed. However, during the lifetime of the trust, default beneficiaries are only eligible to receive benefits if they are also included within the broader class of discretionary beneficiaries.

How Do Expats Benefit From Setting Up a Discretionary Trust?

For UK expats, the benefits of a discretionary trust extend beyond basic estate planning and typically include:

1. Asset protection
2. Tax efficiency
3. Wealth preservation
4. Distribution flexibility
5. Enhanced privacy
6. Simplified cross-border asset management

Asset Protection

A discretionary trust can serve as an effective mechanism for protecting assets from various risks and liabilities. As the trust itself holds legal ownership of the assets—rather than the beneficiaries—those assets are generally shielded from personal creditors, bankruptcy proceedings, or other legal claims involving the settlor or the beneficiaries.

However, UK courts can set aside transfers made to defeat legitimate creditors under the Insolvency Act 1986 and can vary nuptial settlements on divorce under the Matrimonial Causes Act 1973.

While a trust provides meaningful protection, it must not be used to evade legitimate debts or defraud creditors, as such actions may be legally challenged in courts.

Tax Efficiency

With adequate financial planning, discretionary trusts allow UK expats to reduce or potentially eliminate inheritance tax (IHT) liability by effectively excluding assets from the settlor’s estate.

From 6 April 2025, the UK inheritance tax (IHT) system is transitioning from a domicile-based to a long-term residence (LTR) framework. Under the new rules, individuals classified as Long-Term Residents (LTRs)—those who have been UK tax resident for 10 of the previous 20 tax years—will be subject to IHT on their worldwide estate. Conversely, non-LTRs—individuals who have been non-resident for tax purposes for at least 10 of the previous 20 tax years—are liable for IHT only on their UK-situs assets, subject to any applicable double-tax treaties.

Additionally, when assets are gifted into a discretionary trust during the settlor’s lifetime, and the settlor survives for at least seven years following the transfer, those assets are generally excluded from the settlor’s taxable estate for IHT purposes—provided they are not classified as gifts with reservation of benefit (GROB).

A gift with reservation of benefits (GROB) arises when a donor retains ongoing benefits from an asset that has formally been given away. For example, gifting a home into a trust while still residing in it without paying rent would qualify as a GROB. In such instances, the gift would not be exempt from inheritance tax.

Trustees also have flexibility to distribute trust income, but any distributions carry a 45% tax credit, and beneficiaries reclaim or pay additional tax depending on their own marginal rate. “Income splitting” is therefore limited by the trust’s tax pool and by beneficiary residence status.

While the potential tax advantages of discretionary trusts are considerable, obtaining professional advice is essential to ensuring compliance with applicable tax regulations and structuring the trust to minimise tax liability.

Expat tax advisers at Titan Wealth International are well-equipped to assist in establishing tax-efficient discretionary trusts, ensuring compliance with cross-border tax regulations, and developing broader estate planning strategies.

Wealth Preservation

In addition to estate planning, discretionary trusts serve as an effective instrument for preserving family wealth across generations, particularly when beneficiaries may not be well-equipped to manage substantial financial assets. Trustees are entitled to distribute funds only when deemed appropriate, such as for a home purchase or education, ensuring the trust funds are spent rationally.

In addition, discretionary trusts contribute to long-term wealth preservation by minimising exposure to probate costs and avoiding potential family disputes. With careful structuring, a trust can ensure that assets are distributed in accordance with the settlor’s intentions, retaining them within the family and reducing the risk of wealth erosion or mismanagement over time.

Distribution Flexibility

Trustees have the discretion to allocate funds based on beneficiaries’ individual needs, financial circumstances, and tax considerations, allowing them to adjust distributions as necessary.

Distributions can also be tailored to address specific purposes, such as funding education or supporting individuals with special requirements, ensuring the trust’s assets are utilised effectively and in line with the settlor’s intentions.

Enhanced Privacy

A discretionary trust offers a higher level of privacy by keeping financial matters confidential and out of the public domain.

Unlike wills, which become public records after the probate process, the terms and details of a trust remain private, but most UK-connected trusts must register on HMRC’s Trust Registration Service (TRS). Certain information may be shared with parties demonstrating a “legitimate interest” or where the trust holds or controls an offshore company.

UK Tax Treatment of Discretionary Trusts

The UK tax treatment of discretionary trusts involves several types of taxes that can significantly impact the structure and value of the trust. Key taxes that expats must take into account include:

1. Inheritance tax
2. Income tax
3. Capital gains tax
4. 10-year periodic charge
5. Exit charge

Inheritance Tax

Gifts made to discretionary trusts during the settlor’s lifetime are treated as Chargeable Lifetime Transfers (CLTs) and are subject to an immediate 20% lifetime IHT charge on the value above the available nil rate band at the time of transfer (currently £325,000).

For Long-Term Residents (LTRs) under the new rules from 6 April 2025, IHT applies to worldwide assets; for non-LTRs, liability is limited to UK-situs assets (subject to any applicable double-tax treaties). The 20% lifetime rate applies only to the excess above the nil rate band—not to the full transfer value.

Restructuring can sometimes alter the situs of assets, but UK residential property and related loans remain within IHT even when held through offshore entities, due to anti-avoidance legislation introduced in 2017. Furthermore, under the 2025 LTR framework, the excluded property status of non-UK assets in trust depends on the settlor’s LTR status at the time of each chargeable event, and may change if the settlor later reacquires UK LTR status.

In addition, several exemptions can reduce the IHT liability on gifts to discretionary trusts. For instance, the settlor’s annual exemption allows up to £3,000 per tax year in gifts to be made free of IHT, with the possibility of transferring up to £6,000 (in the event of joint settlors) if the exemption has not been used in previous years.

The normal expenditure from income exemption allows the settlor to make regular gifts to a discretionary trust without incurring IHT, provided they can prove that these gifts are made from surplus income and do not reduce their normal standard of living.

IHT charges may arise if the settlor passes away within seven years of creating the trust. In such cases, the transferred assets may become taxable at the standard death rate of 40%. However, taper relief reduces the tax due on the gift (not the transfer value) if the settlor dies between three and seven years following the transfer. The taper relief applies as follows:

Income Tax

From 6 April 2024, most discretionary trusts benefit from a £500 de minimis allowance. If total income for the year does not exceed £500, no income tax is due. If income exceeds this limit, the entire amount is taxable at the following rates:

• 45% on non-dividend income
• 39.35% on dividend income

If an individual has established five or more trusts, the £500 allowance is divided equally (minimum £100 per trust).

When trustees distribute income, it is deemed paid after deduction of 45% tax. Beneficiaries receive an R185 certificate confirming the tax paid. They must declare the grossed-up income, paying additional tax if their marginal rate exceeds 45% or reclaiming if it is lower.

For non-UK resident beneficiaries, double tax treaties and UK withholding rules may affect their ability to reclaim or offset this tax.

Capital Gains Tax

Discretionary trusts are subject to CGT when trustees dispose of assets and realise a gain. For the 2024/25 tax year, trustees have an annual exempt amount (AEA) of £1,500, which is half the individual exemption (£3,000).

Any gains above this threshold are subject to CGT at 24% on disposals made on or after 30 October 2024, for both residential and non-residential assets. (The previous higher 28% rate for residential property was abolished.)

10-Year Periodic Charge

Discretionary trusts are treated as relevant property trusts and may be subject to a 10-yearly inheritance tax (IHT) charge. The effective rate is up to 6% on the value of the trust assets above the nil rate band on each 10-year anniversary. No charge arises if the trust value remains within the available nil rate band.

Under the LTR framework (from 6 April 2025), whether non-UK assets are excluded property depends on the settlor’s LTR status at the time of the charge. If the settlor is not an LTR at that time, non-UK assets are excluded from the periodic charge. Transitional rules preserve excluded-property status for certain assets settled before 30 October 2024.

Expats planning to return to the UK should note that reacquiring LTR status can bring previously excluded assets within scope of periodic charges. Professional financial planning is essential to avoid inadvertent exposure.

Exit Charge

An exit charge may apply when capital is distributed from a discretionary trust to beneficiaries. This applies only to capital distributions (not income).

The rate of the exit charge depends on the timing of the distribution:

• During the first 10 years: Based on a notional effective rate calculated from the initial transfer value and IHT rules at creation.
• After the first 10 years: Based on the effective rate applied at the last 10-year anniversary, adjusted for the nil rate band at the time of distribution.

The effective rate is then pro-rated according to the number of full quarters since the trust was established or since the last 10-year charge.

How To Set Up a Discretionary Trust?

Establishing a discretionary trust typically involves the following steps:

1. Identify suitable assets: The first step is to determine which assets you will settle into the trust. These may include real estate, cash, investments, or personal property. Transferring UK registered pension benefits directly into a private trust is generally not permitted and may result in unauthorised payment tax charges, though separate “bypass” or death benefit trusts can sometimes be used alongside pension arrangements. Depending on your residency status, restructuring your UK-situs assets might be beneficial for IHT purposes, but any restructuring must consider anti-avoidance rules for UK residential property held via offshore entities and the settlor’s long-term residence (LTR) status under the post-April 2025 IHT framework.
2. Define the class of beneficiaries: While common beneficiaries include children, grandchildren, and other relatives, you may specify a broader or more targeted class. All intended beneficiaries should be clearly outlined in the trust deed.
3. Draft the trust deed: The trust deed is the formal legal document that sets out the trust rules, including the trustees’ powers and duties, the scope of discretionary distributions, and the rights of beneficiaries. It must be drafted precisely and according to the relevant jurisdiction’s trust law. Professional legal drafting is advised to prevent ambiguity and ensure your wishes are respected. If any part of the trust is expected to have UK connections or UK-situs assets, the deed should also consider the requirements of the UK Trust Registration Service.
4. Prepare a letter of wishes (optional): While not legally binding, a letter of wishes is a valuable tool that can guide trustees in exercising their discretion. It allows you to communicate your intentions clearly, such as prioritising distributions for education or healthcare expenses. The letter should be drafted clearly, reviewed regularly, and maintained as a confidential document shared solely between you and the trustees.
5. Appoint trustees: The choice of trustees is critical. They should be trustworthy, impartial, and capable of handling complex fiduciary duties. Many settlors choose a combination of family members and professional trustees to balance personal insight with legal and financial expertise. Trustees must also comply with ongoing reporting obligations, including TRS registration, annual tax filings (if UK-taxable), and periodic valuation requirements.
6. Fund the trust: Once established, you may fund the trust by transferring the selected assets. It is essential to ensure compliance with tax regulations and reporting requirements at the time of transfer, so consulting an adviser before funding the trust is highly recommended. Transfers into trust may constitute chargeable lifetime transfers (CLTs) for UK IHT purposes and could trigger capital gains tax (CGT) if assets are disposed of; advice should be obtained on reliefs such as hold-over relief before completion.