Discretionary Trusts Explained: What Every Family Should Know

A discretionary trust is the most widely used form of family trust in the UK — and for good reason. It gives trustees broad flexibility to respond to changing family circumstances, while providing legal protection for the assets it holds. But that flexibility comes with real responsibility, and families who misunderstand how discretionary trusts work often end up with problems their solicitor told them they would avoid.

What Is a Discretionary Trust?

In a discretionary trust, the trustees have full discretion to decide how, when, and to whom they distribute income and capital from the trust fund. Unlike a bare trust — where the beneficiary has an immediate, absolute right to the assets — no beneficiary of a discretionary trust has an automatic entitlement to anything.

This discretion is the defining feature. It allows trustees to respond to changes in beneficiaries' circumstances, protect assets from divorce or bankruptcy proceedings, and support vulnerable beneficiaries in a controlled way.

Who Controls a Discretionary Trust?

The trustees control the trust. They are the legal owners of the trust assets and are legally obliged to act in the interests of the beneficiaries as a whole. Their decisions are governed by the terms of the trust deed, the general law of trusts, and their fiduciary duties.

The settlor can express wishes and preferences — particularly through a letter of wishes — but once the trust is established, the settlor has no legal right to direct the trustees. If the settlor retains too much control, HMRC may treat the trust as a 'settlor-interested' arrangement, with adverse tax consequences.

What Assets Can a Discretionary Trust Hold?

Almost any asset can be held in a discretionary trust: residential and commercial property, investment portfolios, shares in private companies, cash, life assurance policies, intellectual property, and valuable personal property.

The practicalities of holding each asset type differ. Property requires formal transfer and Land Registry registration. Shares require stock transfer and company register updates. Each transfer creates a formal record that should be retained as part of the trust's documentary history.

Tax Treatment of Discretionary Trusts

Discretionary trusts are subject to their own tax regime, which is separate from the personal tax position of the settlor or the beneficiaries.

Income tax: Trustees pay income tax at the trust rate (currently 45% on income above the standard rate band of £1,000). When distributions are made to beneficiaries, they can reclaim some of this tax if they are lower-rate taxpayers.

Frequently Asked Questions

Can the settlor be a beneficiary of their own discretionary trust?

Yes, but this creates a 'settlor-interested' trust, which has different and generally less favourable tax treatment. HMRC will treat income and gains of a settlor-interested trust as arising to the settlor personally.

Can a discretionary trust last forever?

UK trusts are subject to the rule against perpetuities. Most trusts drafted since 2010 run for a defined period — typically 125 years under the Perpetuities and Accumulations Act 2009. After that, the assets must be distributed.

What is the difference between a discretionary trust and a bare trust?

In a bare trust, the beneficiary has an immediate, absolute right to the assets. In a discretionary trust, no beneficiary has an automatic entitlement — the trustees decide how and when assets are distributed.

Do trustees have to follow the settlor's letter of wishes?

No. A letter of wishes is non-binding guidance. Trustees must consider it seriously, but they are not legally obliged to follow it. Their overriding duty is to act in the best interests of the beneficiaries as a whole.