IHT and Discretionary Trusts: A Smart Tool for Estate Planning

Inheritance Tax (IHT) remains one of the most significant risks to passing on wealth efficiently. One strategic option often overlooked is the use of discretionary trusts.

In this article, we’ll explain what discretionary trusts are, how they work within the IHT framework, and the potential benefits and drawbacks to consider.

What Is a Discretionary Trust?

A discretionary trust is a type of trust where the trustees have full discretion over how and when to distribute income or capital to beneficiaries. Unlike a fixed trust, beneficiaries do not have an automatic right to the assets. Decisions are made at the trustees’ discretion.

This flexibility makes discretionary trusts especially useful for:

• – Protecting assets
• – Supporting beneficiaries
• – Managing complex family arrangements
• – Reducing exposure to IHT

How Discretionary Trusts Are Treated for IHT

Since 22 March 2006, discretionary trusts fall within the “relevant property” regime for IHT. That means they face specific charges, including:

Lifetime charge

If you transfer assets above the nil-rate band (£325,000) into a discretionary trust during your lifetime, there may be an immediate 20% IHT charge.

Periodic charge

Every 10 years, the trust may be subject to a “periodic” IHT charge of up to 6% of the value of assets held.

Exit charge

When assets are distributed from the trust, a proportionate IHT charge may also apply.

These charges may seem complex, but they usually cost far less than the 40% IHT charge you would pay if you held the assets directly in your estate.

Key Benefits of Using a Discretionary Trust

Despite the tax rules, discretionary trusts remain a highly effective tool in certain scenarios:

Keeps assets outside of your estate

Once placed in the trust, assets are no longer counted as part of your estate for IHT

Flexibility for changing circumstances

Trustees can adapt distributions based on beneficiaries’ needs over time.

Protects beneficiaries

Useful for families with younger heirs, blended families, or where asset protection is important.

Control

You can outline guidance for trustees to follow, helping ensure your wealth is used responsibly.

 Things to Watch Out For

• – Upfront tax charge – Gifts into trust above the nil-rate band may trigger a 20% charge.
• – Ongoing admin – Trustees must handle reporting requirements, including 10-year reviews.
• – Access – Once in trust, assets are no longer yours to reclaim or have use of.

You should seek professional advice before setting up a trust so you can structure it in the most efficient way for your circumstances.

Your Guide to the New IHT Rules

We’ve created an in-depth, comprehensive guide to help you understand the new IHT rules, what they mean for your estate, and how you can act now to protect your wealth.

Download our guide ‘Navigating the 2027 Inheritance Tax Changes on Pensions’ here.

Want to know more? Book a free 20-minute consultation with one of our advisors to see how trusts and other mitigation strategies could work for you.

Mitigating Your IHT Exposure

Discretionary trusts are not a one-size-fits-all solution. However, for many families they provide a valuable way to shield assets from inheritance tax, protect beneficiaries, and maintain flexibility over how wealth is distributed.

With the upcoming IHT changes, now is the right time to review whether a discretionary trust could fit into your estate planning strategy.