Discretionary income payments to beneficiaries

When trustees make a discretionary payment of income it carries a tax credit at the trust rate (currently 50 per cent). This means it is treated in the hands of the beneficiary as if Income Tax has been already paid at 50 per cent. The beneficiary might be able to claim some or all of the tax back if they're a non-taxpayer or a 20 or 40 per cent taxpayer.

Trustees of a discretionary trust - or an accumulation trust where they also have the power to make discretionary payments - need to make sure that they've paid enough tax to cover the tax credit given to the beneficiary. They do this using a process called the 'tax pool', which keeps a record of all discretionary income payments made by the trustees, and the tax the trustees have paid. Different rules apply for payments to beneficiaries of settlor interested discretionary trusts.

Discretionary or accumulation trusts with vulnerable beneficiaries

A discretionary or an accumulation trust may be used to help a 'vulnerable beneficiary'. A vulnerable beneficiary is someone who is:

  • mentally or physically disabled
  • a child below the age of 18 who has lost a parent through death

A trust set up for the benefit of a vulnerable beneficiary may qualify for special tax treatment.

Discretionary or accumulation trusts and Inheritance Tax

There may be an Inheritance Tax charge when:

  • assets are put into a discretionary trust
  • a discretionary trust reaches a ten-year anniversary
  • assets are taken out of a discretionary trust or the trust ceases

Sometimes Inheritance Tax uses different terminology for trusts. Discretionary trusts may fall within what are known as 'relevant property' trusts.