A discretionary trust in the UK is a type of trust where the trustees have full discretion over how to distribute the trust income and capital among a class of beneficiaries. The beneficiaries do not have a fixed entitlement to the assets or income of the trust — it's up to the trustees to decide who gets what, when, and how much.
Key Features of a Discretionary Trust:
- Trustees' discretion: Trustees decide which beneficiaries benefit, how much they receive, and when.
- Letter of wishes: Although not legally binding, settlors often provide this document to guide trustees.
- Class of beneficiaries: Rather than naming specific individuals, the trust may refer to a group (e.g., “my children and grandchildren”).
- Protects assets: Useful for protecting assets from beneficiaries' creditors or poor financial decisions.
- Taxation: The trust is subject to specific tax rules.
Common Uses:
- Estate planning
- Providing for children or vulnerable family members
- Asset protection in divorce or bankruptcy situations
This type of trust is far from ideal for the average person because paying tax and cost of maintaining the trust can significantly reduce the amount of money available to the beneficiaries.
Tax Disadvantages
Discretionary trusts are heavily taxed compared to individuals or other types of trusts:
- Income Tax: Income over £1,000 is taxed at 45% (the trust rate).
- Capital Gains Tax (CGT): Lower annual exemption than individuals and taxed at 20% (28% for residential property).
- Inheritance Tax (IHT):
- Periodic charge: Up to 6% every 10 years on assets above the nil-rate band (£325,000).
- Exit charge: Applied when assets are distributed.
A significant portion of the trust's returns can be lost to tax.
Complexity and Administration Costs
Discretionary trusts require:
- Ongoing legal and financial advice
- Annual tax returns (self-assessment)
- Trustee meetings and formal decision-making
This can mean high professional fees and burdensome paperwork over time.
Regulatory and Reporting Burdens
Post-Brexit and under anti-money laundering rules, UK discretionary trusts:
- Must be registered on HMRC’s Trust Registration Service (TRS).
- Face increasing scrutiny, especially around transparency of beneficial ownership.
WTEP Ltd trading as Westminster has never sold this type of trust as it believes they are far from ideal for the average person because paying tax and the high cost of maintaining the trust can significantly reduce the amount of money available to the beneficiaries.