Discretionary Trusts vs Bare Trusts: Key Differences

When advisers and clients discuss trust planning, the distinction between a discretionary trust and a bare trust is fundamental. They share the basic legal architecture — assets held by trustees for beneficiaries — but differ sharply in flexibility, tax treatment, and the rights they give to beneficiaries. Getting the choice right matters enormously, particularly for internationally mobile families where the wrong structure can create unintended tax exposures in multiple jurisdictions.

This guide sets out the key differences in plain terms, with practical guidance on when each is appropriate. It does not constitute legal or tax advice, and individual circumstances require professional review before any structure is established.

The Essential Distinction

The defining difference is discretion:

• In a bare trust, the beneficiary has an immediate, unconditional right to the trust assets. The trustee holds the assets as a nominee only; they have no discretion over distributions. The beneficiary can demand the assets at any time (once legally adult and mentally capable).

• In a discretionary trust, no beneficiary has a fixed entitlement. The trustees decide, at their discretion, which beneficiaries receive distributions, when, and in what amount. Beneficiaries have only a hope of benefiting, not a legal right.

This distinction drives everything that follows — from tax treatment to asset protection to succession planning.

Bare Trusts: Characteristics and Uses

Legal Position

In a bare trust, the trustee is the legal owner of the assets, but the beneficial owner (the beneficiary) is the economic owner. The trustee acts purely as a nominee, holding assets until the beneficiary chooses to call for them. There is no ongoing management discretion.

Tax Treatment

Because the beneficiary is the economic owner, all income and capital gains within a bare trust are taxed on the beneficiary — not the settlor, not the trustee. This makes bare trusts:

• Efficient where the beneficiary is in a lower tax bracket than the settlor (for example, an adult child with no income of their own).
• Transparent for UK tax purposes — HMRC treats the assets as belonging to the beneficiary from the moment the bare trust is created.
• Subject to the parental settlement rules: where a parent creates a bare trust for a minor child, income exceeding £100 per year is treated as the parent's income, not the child's. This significantly limits the income tax benefit for parents.

For inheritance tax, a transfer into a bare trust is treated as an outright gift — a Potentially Exempt Transfer (PET). If the settlor survives seven years, there is no IHT charge. The assets leave the settlor's estate on the date the trust is created.

For capital gains tax, the creation of a bare trust is not itself a disposal (the beneficiary is treated as having always owned the assets). When the assets are eventually transferred out of the bare trust to the beneficiary, there is no CGT event at that point either. A CGT event occurs when the beneficiary subsequently disposes of the assets.

Typical Uses

• Holding assets for children or grandchildren until they reach adulthood (18 in England, 16 in Scotland). The Junior ISA and Child Trust Fund operate on bare trust principles.
• Nominee arrangements for adult clients who wish legal title to be held in a different name (for privacy, administrative convenience, or foreign property ownership requirements where foreigners cannot hold land directly).
• Simple gift to a known individual where the immediate and unconditional nature of the transfer is appropriate and no ongoing management or discretion is needed.

Key Limitations

• No flexibility: once established, the trustee cannot redirect assets to a different beneficiary or retain income. The beneficiary is absolutely entitled.
• Age risk: the beneficiary receives the assets at adulthood. For parents concerned about a child's maturity or financial responsibility, receiving a substantial sum at 18 may not be ideal.
• Parental settlement rules: limit the income tax advantage where minor children are involved.

Discretionary Trusts: Characteristics and Uses

Legal Position

In a discretionary trust, the trustees hold assets on behalf of a class of potential beneficiaries and exercise discretion about who benefits, when, and how much. Common classes might include "the settlor's children and grandchildren" or "any individuals named in the settlor's letter of wishes". No single beneficiary has a current entitlement to any specific asset.

Tax Treatment

Discretionary trusts are significantly more complex from a tax perspective than bare trusts.

Income tax: Income arising within a UK discretionary trust is taxed at the trust rate — 45% on income other than dividends (39.35% on dividend income) as of 2026, with a standard rate band of £1,000 per year. When income is distributed to beneficiaries, the tax suffered by the trust is credited against the beneficiary's liability, and lower-rate taxpayers can reclaim the difference. This makes discretionary trusts less efficient for simple income distribution than some alternatives, but they retain flexibility.

Capital gains tax: Gains within a discretionary trust are taxed at the trust rate (20% for most assets; 24% for residential property as of 2026). Trusts have a reduced annual CGT exemption (currently half the individual exemption). Holdover relief — which allows gains to be deferred when assets are transferred into or out of a trust — is available in specific circumstances, particularly for qualifying business assets.

Inheritance tax: Discretionary trusts sit within the relevant property regime:

• On creation (transfer of assets in), a chargeable lifetime transfer (CLT) arises. If the amount transferred exceeds the settlor's available nil rate band (£325,000), the excess is taxed at a lifetime rate of 20%.
• Every 10 years, the trust assets above the nil rate band are subject to an anniversary charge of up to 6%.
• When assets leave the trust (exit charges), a proportion of the anniversary charge accrues and is paid.

The combination of entry charges, anniversary charges, and exit charges means discretionary trusts are not a "free" IHT shelter — they are a managed deferral and spreading mechanism. For many estates, the long-term saving substantially outweighs the ongoing trust charges, particularly where asset values grow significantly over time.

Asset Protection

Because no beneficiary has a fixed entitlement, creditors of a beneficiary cannot typically compel distributions from a discretionary trust. This makes discretionary trusts significantly more effective for asset protection than bare trusts.

Typical Uses

• IHT planning for larger estates: removing assets from the estate while maintaining trustee control over how and when beneficiaries benefit.
• Protecting assets from beneficiary risk: useful where beneficiaries may be vulnerable, have creditor issues, or are minors where the parental settlement income rule is not a concern (grandparent to grandchild trusts avoid the parental rule).
• Multi-generational planning: the class of beneficiaries can include future generations not yet born.
• Flexible succession: trustees can adapt distributions to reflect changing family circumstances over decades.

Key Limitations

• Complexity and cost: discretionary trusts require ongoing administration, accounts, annual compliance, and trustee fees. HMRC's Trust Registration Service requires registration. Annual charges (particularly the 10-year anniversary charge) must be managed.
• No individual entitlement: beneficiaries cannot compel a distribution, which can create family tension if the settlor's intentions are not clearly communicated via a Letter of Wishes.
• IHT charges are unavoidable: the relevant property regime imposes real costs. Proper actuarial and tax modelling should be done before establishment to confirm the long-term benefit.

Side-by-Side Comparison

Feature	Bare Trust	Discretionary Trust
Beneficiary entitlement	Absolute and immediate	None — subject to trustee discretion
Income tax	Taxed on beneficiary	Taxed at trust rate (45%/39.35%); creditable on distribution
Capital gains tax	Taxed on beneficiary; no disposal on creation or exit	Taxed on trust at trust rate; holdover relief in some cases
IHT on creation	PET (no immediate charge if within NRB)	CLT (20% if exceeds available NRB)
IHT ongoing	No anniversary or exit charges	10-year anniversary (up to 6%) and exit charges
IHT on death within 7 years	PET becomes chargeable; taper relief applies	Already a CLT; further IHT only if settlor dies within 7 years
Asset protection	Weak — beneficiary's creditors can reach assets	Strong — no fixed entitlement
Flexibility	None	High — trustees exercise ongoing discretion
Typical use	Holding assets for a known individual	Multi-generational family planning, IHT mitigation, protection
Administrative cost	Low	Higher

Interest in Possession Trusts: A Middle Ground

It is worth noting that between bare trusts and discretionary trusts sits the interest in possession (IIP) trust, where a named beneficiary (the "life tenant") has the right to trust income as it arises, while the underlying capital passes to another beneficiary (the "remainderman") on a future event, such as the life tenant's death.

IIP trusts created from 22 March 2006 onwards generally fall within the relevant property regime for IHT purposes (with limited exceptions). They remain useful in certain estate planning contexts — particularly where providing an income stream for a surviving spouse while protecting the capital for children is the objective.

Interaction with Offshore Planning

For non-UK resident settlors and beneficiaries, offshore discretionary trusts (governed by Jersey, Guernsey, Cayman Islands, or other common law offshore centre law) can provide tax deferral opportunities that onshore UK trusts cannot. The UK's anti-avoidance rules for offshore trusts — including the Transfer of Assets Abroad provisions, the benefits charge for UK-resident beneficiaries, and the offshore income gains provisions — are extensive. These rules are addressed in more detail in a separate article on offshore trusts.

The choice between an offshore discretionary trust and an onshore one is not simply a matter of tax; it also involves governance, regulatory environment, trustee availability, and the residency profile of family members.

How Global Investments Can Help

Choosing between a discretionary trust and a bare trust — or selecting an entirely different structure — depends on the specific facts of each family's situation. At Global Investments, we work with specialist legal and tax advisers to help clients understand which structures serve their objectives most effectively and cost-efficiently.

We help internationally mobile families to:

• Assess whether a trust structure is genuinely appropriate for their circumstances.
• Model the long-term IHT and tax implications of different trust types.
• Identify the right jurisdiction and governing law for offshore structures.
• Draft and review letters of wishes that guide trustee decisions.
• Ensure ongoing compliance with UK and international reporting requirements.
• Review and update trust structures as the law and family circumstances change.

Tax rules are complex and frequently change. Nothing in this guide constitutes legal or tax advice. The information reflects the position as of 2026 and individual circumstances will differ significantly. Please seek qualified professional advice before establishing any trust.