A discretionary settlement is a trust in which the trustees, not the settlor and not the beneficiaries, decide who receives money from the fund, how much, and when. The trust deed names a class of potential beneficiaries, but nobody in that class has a fixed share or a right to demand a payment. That flexibility is the whole point, and it is also why discretionary settlements sit inside one of the strictest tax regimes in UK private client law, with a 20% entry charge above the nil rate band, periodic charges of up to 6% every ten years, and trustee income tax at 45%.
The rest of this guide walks through what you get for that cost: how to set one up properly, what trustees are allowed to do, what beneficiaries can insist on, the full tax picture, and the 2025 residence changes that have pulled a lot of previously safe offshore trusts back into the UK net.
What a Discretionary Settlement Actually Is
In a fixed trust, the deed spells out entitlements. A named beneficiary might have all the income for life or a set percentage of capital at a given age, and the trustee’s role is largely administrative. A discretionary settlement inverts that. The deed identifies a pool of possible beneficiaries and hands the trustees full authority over who benefits and when.
Beneficiaries of a discretionary settlement hold no “interest in possession” in the trust property. They cannot demand a payment, and until the trustees decide to make one, they have no proprietary claim on anything in the fund. As Cornell’s legal encyclopedia puts it, discretionary beneficiaries “technically have no rights to distributions,” and the trustee retains “complete discretion on when and what amounts of assets to distribute.”
That single feature drives most of what follows. Because no beneficiary owns a defined share, creditors generally cannot reach the fund through a beneficiary’s interest. Because nothing is fixed, trustees can respond to changes in family life, health, or law that a rigid trust could not accommodate. And because the settlor has genuinely given the assets away, HMRC treats the trust as a separate taxable entity with its own regime.
Setting One Up
A discretionary settlement can be created during the settlor’s lifetime by signing a trust deed, or on death through a will. Either way, English law requires the “three certainties”:
- Certainty of intention — the wording has to show that a binding trust is intended, not just a gift or a wish.
- Certainty of subject matter — the property going into the trust has to be clearly identified.
- Certainty of objects — the class of potential beneficiaries has to be defined precisely enough that you can say whether any given person is or is not in it.
That third test comes from the House of Lords decision in McPhail v Doulton [1971] AC 424, which replaced an older rule requiring a complete list of every possible beneficiary. A discretionary trust is valid as long as it can be said with certainty whether any individual “is or is not” within the class. Trusts of land must be declared in writing and signed under the Law of Property Act 1925. A discretionary trust in a will has to meet the usual Wills Act 1837 formalities, including two witnesses.
Registering the Trust
Most express UK trusts, including discretionary settlements, have to be registered on HMRC’s Trust Registration Service. New trusts must generally be registered within 90 days of creation. Failing to register, or failing to keep the register up to date, can bring penalties of up to £5,000 per offence for deliberate non-compliance, issued to the lead trustee, who is personally liable. HMRC typically sends a warning letter before fining a first-time slip, but deliberate or repeated failures attract harsher treatment. Since September 2022, banks, insurers, and investment firms have been prohibited from opening new business relationships with trustees who cannot show proof of TRS registration, so a trust that is not registered quickly stops being able to function.
What Trustees Can and Cannot Do
The defining feature of a discretionary settlement is the width of trustee authority. Trustees typically decide which members of the class benefit, in what amounts, and when. A well-drafted deed may also let them add people to the class or remove them, responding to births, marriages, or estrangement.
Discretion is not a free hand, though. Trustees cannot act dishonestly, from an improper motive, or in a way that frustrates the trust’s purposes. Even language granting “absolute discretion” does not put a trustee beyond judicial review. Legal scholar Richard C. Ausness concluded in a 2018 analysis that “no language, however broad, can completely shield a trustee from judicial scrutiny.”
Where courts look at whether a trustee has abused their discretion, they weigh the scope of discretion given by the deed, the purposes of the trust, the trustee’s motives, whether there is a conflict of interest, and whether the deed sets any external standard (for example, distributions for a beneficiary’s health, education, maintenance, and support).
Letters of Wishes
Because trustees have such wide latitude, settlors usually prepare a “letter of wishes” alongside the deed, setting out preferences on how the trustees should exercise their powers and which beneficiaries the settlor sees as most deserving.
The letter is not legally binding. Trustees who simply follow it without exercising their own judgment would be breaching their fiduciary duty. The Supreme Court in Pitt v Holt [2013] UKSC 26 confirmed that a settlor’s wishes are “always a material consideration in the exercise of fiduciary discretions,” but material consideration is not the same as an instruction. Trustees are entitled to depart from the wishes in good faith where they judge that the beneficiaries’ interests require it.
Wish letters are also generally confidential. In Breakspear v Ackland [2008] EWHC 220 (Ch), the High Court held they fall within the principle that the process by which trustees exercise dispositive discretion is inherently private. Trustees have a fiduciary discretion whether to disclose, and courts will only review that decision for honesty, fairness, and rationality. The Privy Council added in Grand View v Wong [2022] UKPC 47 that a letter written when the trust was created can be used to work out the “proper purpose” of a trustee power, but a later letter expressing changed wishes cannot.
What Beneficiaries Can Do
A discretionary beneficiary’s position is often described as a “mere expectancy” rather than an entitlement. You cannot compel a payout, and you hold no proprietary interest in the fund until the trustees actually apply assets in your favor.
Beneficiaries are not powerless, though. The Privy Council in Schmidt v Rosewood Trust Ltd [2003] UKPC 26 established that even a discretionary beneficiary can seek disclosure of trust documents, not as a proprietary right but as an aspect of the court’s inherent jurisdiction to supervise trust administration. The court said “no beneficiary (and least of all a discretionary object) had any entitlement as of right to disclosure,” but it still granted access to trust documents subject to confidentiality protections.
In practice, beneficiaries of a discretionary settlement are generally entitled to know that the trust exists and to understand their potential interest. They can ask for trust accounts, deeds of appointment, and records of distributions, and trustees have to justify any refusal. An unjustified refusal can expose the trustee to personal liability for costs or removal from office.
Challenging an actual distribution decision is much harder. “Unfair” is not enough. The grounds are narrow: breach of trustee duties, failure to consider relevant matters, consideration of irrelevant ones, a genuine mistake, “fraud on the power” (using it for an improper purpose), or undue influence. The English High Court in Seymour v Ragley Trust Company [2025] EWHC 1099 (Ch) reaffirmed that removing a trustee is a “last resort,” holding that a breakdown in personal relationships and allegations of bias were not enough where no actual misconduct was proven.
UK Tax on a Discretionary Settlement
Discretionary settlements are taxed at three stages: when assets go in, while they sit in the trust, and when they come out. The regime is set by the Inheritance Tax Act 1984, sections 58 to 69, which treats a discretionary settlement as a “relevant property” trust.
Putting Assets In
Gifts into a discretionary trust during the settlor’s lifetime are chargeable lifetime transfers. If the cumulative value of such transfers exceeds the nil rate band (currently £325,000, frozen until April 2031), the excess is subject to an immediate 20% tax charge. If the settlor dies within seven years, more tax may be due at the full 40% death rate, with taper relief potentially reducing the liability.
The Ten-Year Charge
Every ten years after the trust’s creation, a periodic charge applies. The maximum effective rate is 6%, calculated as 30% of the 20% lifetime rate, applied to the trust’s net value above the nil rate band.
The Exit Charge
When capital leaves the trust between ten-year anniversaries, an exit charge is levied as a proportion of the rate that applied (or would have applied) at the most recent anniversary, adjusted for the number of complete quarters the property was held. No exit charge applies if assets are distributed within three months of the trust’s creation or within three months of a ten-year anniversary, which is a scheduling point worth remembering when planning distributions.
Income Tax and Capital Gains Tax
Trustees of a discretionary settlement pay income tax at 45% on most income and 39.35% on dividend income, with a tax-free allowance of £500. If a settlor has set up more than one discretionary trust, the allowance is split between them, dropping to £100 per trust once there are five or more.
For capital gains tax, trustees pay at 24% on gains above the annual exempt amount of £1,500, again apportioned across multiple trusts from the same settlor.
Settlor-Interested Trusts
If the settlor or their spouse retains any possibility of benefiting from the trust, the income is taxed on the settlor personally rather than only on the trustees. This “settlor-interested” rule catches situations where trust property or income could be applied for the settlor’s benefit, even if no distribution is actually made. Exceptions cover outright gifts, charitable payments, and specific statutory situations. Where trustees have already paid at the 45% trust rate and the settlor’s personal liability turns out to be lower, the excess is returned to the trustees.
The 2025 Residence Change
The Finance Act 2025 rewired how discretionary settlements with international elements are taxed. From 6 April 2025, UK inheritance tax moved from a domicile-based system to one based on “long-term UK residence.” An individual is a long-term UK resident once they have been tax resident here for at least 10 out of the previous 20 tax years.
For discretionary trusts holding non-UK assets, this matters a lot. Previously, if a settlor was not UK-domiciled when they set up the trust, non-UK assets stayed as “excluded property” indefinitely, sitting outside inheritance tax. Under the new rules, excluded property status is no longer fixed at the date of settlement. It depends on whether the settlor is a long-term UK resident at the time of each chargeable event — a ten-year anniversary, for instance, or an exit. A settlor who was non-domiciled when the trust was created but has since become long-term UK resident now sees non-UK trust assets caught by the relevant property regime, with periodic and exit charges of up to 6%.
Trusts established before 30 October 2024 get partial transitional protection. Property that qualified as excluded property under the old rules is grandfathered from the “gift with reservation of benefit” provisions (which carry a 40% charge), but it remains subject to the standard relevant property charges. Individuals who leave the UK after a long period of residence stay within the inheritance tax net for a “tail” period of three to ten years, depending on how long they were resident.
A separate change takes effect from 6 April 2026: agricultural property relief and business property relief will be capped at a combined £1 million of value at 100% relief, with any excess value receiving only 50%. The nil rate band stays frozen at £325,000 until at least April 2031.
Asset Protection and Creditors
One of the main non-tax reasons people set up discretionary settlements is protection from creditors. Because no beneficiary has a defined share, in principle there is nothing for a creditor to attach.
That protection is strong but not absolute. Certain “favored” creditors can often reach trust assets even where discretionary and spendthrift protections are in place. These typically include:
- Child support and spousal maintenance claims, particularly where the trustee has abused their discretion or failed to follow a distribution standard.
- Providers of services that were specifically for protecting a beneficiary’s interest in the trust.
- Government claims, which are often exempted from spendthrift protection.
Self-settled trusts, where the settlor is also a beneficiary, get much weaker protection. In most systems that follow the Uniform Trust Code, a spendthrift provision is ineffective against a beneficial interest retained by the settlor, and creditors can reach the maximum amount that could be distributed for the settlor’s benefit.
The Trade-Offs
The flexibility of a discretionary settlement is its central attraction. Trustees can direct more support to a family member facing illness, hold back distributions from a beneficiary going through a contentious divorce, or shift investment strategy over time. The structure is also private, since the trust does not become part of the public record in the way a will does after probate.
The costs are real. Trustees carry demanding administrative duties, including annual tax returns, trust registration, anti-money laundering compliance, and detailed record-keeping. Setup costs for a UK discretionary trust typically run from £2,000 to £5,000, with ongoing professional fees on top. The 45% trustee income tax rate on non-dividend income is among the highest available and can erode retained income over time. And once you have transferred assets into an irrevocable discretionary settlement, you have given up legal ownership; changing the terms later is often difficult and expensive.
The most common friction, in the end, is between beneficiaries who want money and trustees whose job is to exercise independent judgment. Disputes over perceived favoritism or inaction are a recurring feature of discretionary trust litigation, and the threshold for successfully challenging a trustee’s decision is high. Anyone setting one of these up should choose their trustees, and draft their letter of wishes, with that reality in view.