With inheritance tax thresholds remaining frozen and unused pensions being added to the value of a deceased’s estate from April 2027, estate planning is becoming a more prominent part of client advice, and more advisers are revisiting trusts as part of their planning conversations. For those less familiar with the area, this note recaps the key features of a discretionary trust before looking at how those principles apply within the Flexible Reversionary Trust (FRT).
What is a Discretionary Trust?
A discretionary trust is a legal arrangement under which assets are transferred to trustees to hold for a defined class of beneficiaries. Unlike a bare trust, no beneficiary has a fixed entitlement to the trust fund. Instead, the trustees decide who benefits, when they benefit, and to what extent. That flexibility is one of the structure’s main attractions, as it allows the trust to respond to changing family circumstances over time.
For inheritance tax (IHT) purposes, a transfer into a discretionary trust is usually a Chargeable Lifetime Transfer (CLT). The nil-rate band (NRB) is currently £325,000 and is frozen at this level until at least 6 April 2028. Any value transferred above the settlor’s available NRB is generally subject to a 20% lifetime IHT charge. In working out how much NRB remains available, earlier CLTs made by the settlor in the previous seven years must also be taken into account.
The seven-year rule and taper relief
If the settlor survives for seven years from the date of the transfer, the value transferred will usually fall outside their estate for IHT purposes. If they die within that seven-year period, the CLT is brought back into account when calculating the IHT position on death.
Where death occurs between three and seven years after the transfer, taper relief can reduce the tax payable at death as follows:
3–4 years: 80% of the full death rate applies
4–5 years: 60% applies
5–6 years: 40% applies
6–7 years: 20% applies
7+ years: no tax is due on that transfer.
Taper relief reduces the tax charge, not the value of the transfer itself. It also only matters where tax is actually payable. If the failed transfer falls wholly within the available nil-rate band, there is no tax to taper.
A failed CLT can also reduce the nil-rate band available for later gifts, including Potentially Exempt Transfers (PETs). This is often referred to in practice as the “14-year rule”, because an earlier CLT can affect the tax treatment of a later PET where the timing of the gifts and death falls in a particular sequence. A simple lifetime gifting log can therefore be extremely valuable when reviewing a client’s position.
Beneficiaries
The trust deed will define the class of potential beneficiaries, for example children, grandchildren, remoter issue (generations beyond grandchildren), or other persons specified in the deed. Named individuals may also be included. The trustees then exercise their discretion to decide who should benefit, when, and in what amounts. A settlor’s expression of wishes can help guide that decision-making, although it is not legally binding.
A wide beneficiary class is one of the discretionary trust’s key strengths. It allows future generations not yet born to be included and helps the trust adapt to changing family circumstances without the need to unwind or rewrite the structure.
Periodic and exit charges
Because assets in a discretionary trust fall within the relevant property regime, there are two ongoing IHT charges to consider: periodic charges and exit charges.
Periodic charges can arise on each ten-year anniversary of the trust. At that point, HMRC values the trust fund and may charge IHT at an effective rate of up to 6% on the value above the available nil-rate band. In practice, the effective rate is often lower, and no charge will arise where the value remains within the available nil-rate band.
Exit charges can arise when capital leaves the trust and is appointed to beneficiaries. These are broadly proportionate charges based on the effective rate at the last ten-year anniversary, or on the entry history where the appointment takes place within the first ten years. Again, where the trust value remains within the nil-rate band, exit charges are often modest or nil.
For many clients, particularly where the value settled is modest relative to the nil-rate band, these charges are not a significant barrier. They do, however, form part of the overall suitability assessment and should be considered alongside the wider planning objectives.
The Flexible Reversionary Trust
The Flexible Reversionary Trust (FRT) is a single-settlor discretionary trust, so the general IHT framework described above still applies. The distinguishing feature is that the settlor retains a right for selected parts of the trust fund to revert to them at pre-determined future dates. That retained right is the reversion.
This can make the FRT a useful structure for clients who want to begin moving value outside their estate, but who are not yet comfortable giving up access entirely. The FRT is designed to hold an investment bond and, on the Transact platform, can be used with either an onshore or offshore bond. The bond can be issued as up to 1,000 individual policies (segments), which provides useful flexibility over how much may vest back to the settlor and how much remains for beneficiaries over time.
The initial transfer into the FRT is a CLT, and the seven-year period runs from the date the bond is placed into trust. Subject to the terms of the trust and the retained reversions, future growth on the trust property will generally sit outside the settlor’s estate immediately.
How the reversion works
When the FRT is established, the settlor completes a schedule showing which policies may revert to them and in which future policy anniversaries. Those dates are the vesting dates.
On each vesting date, the default position is that the selected policies revert to the settlor, but the trustees can decide otherwise. Their options are:
Allow the reversion to take effect, so the relevant policies return to the settlor. This is the default position if no other action is taken.
Defer the reversion for a future anniversary, allowing the position to be reviewed again later.
Defeat the reversion, so the relevant policies are held thereafter for beneficiaries and can no longer revert to the settlor.
Any policies not included in the reversion schedule, or whose reversions have been defeated, are held solely for the beneficiaries. On the settlor’s death, any policies that have not yet reverted will remain subject to the trust and pass for the benefit of the beneficiaries rather than falling into the settlor’s estate. As a result, those trust assets can generally be dealt with without waiting for probate on the settlor’s estate.
Under the current FRT structure, a vesting back to the settlor is not normally treated as a chargeable exit for IHT purposes, so the reversion itself does not typically trigger an exit charge. The trust nevertheless remains within the relevant property regime, so the usual periodic and exit charge rules still apply in relation to trust property held for beneficiaries.
A note on gift with reservation of benefit
Because the settlor retains a right to future benefit under the trust terms, the arrangement must be established and operated carefully. The trustees must exercise genuine and independent discretion. If HMRC considers that the settlor has retained a benefit beyond the intended reversionary rights, the arrangement could fall within the gift with reservation rules, with the result that value remains within the settlor’s estate for IHT purposes.
For that reason, including at least one independent, and ideally professional, trustee is more than good practice: it helps support the integrity of the planning and the quality of trust administration. Trustees should meet regularly, minute their decisions carefully, and make deferral or defeat decisions in good time before each vesting date.
Key message
Trusts are becoming a more prominent part of estate planning conversations, and a sound understanding of the discretionary trust is a useful starting point. The FRT builds on those foundations by adding structured flexibility around future access. That can make it a useful option for clients who want to begin reducing the value of their estate without making an outright and irreversible gift from day one.
All information is based on our understanding and interpretation of applicable law and regulation which is subject to change. Tax treatment depends on individual client circumstances and may change in the future.