Trusts and Inheritance Tax: The 10-Year Charge and Exit Charge Worked Through
Most discretionary (relevant property) trusts face three separate Inheritance Tax points: a 20% entry charge on anything settled above the £325,000 nil-rate band, a periodic charge of up to 6% every 10 years, and a proportionate exit charge when capital leaves between anniversaries. This guide runs each one through with real numbers — including a £600,000 settlement that triggers a £55,000 entry charge.
Trusts and Inheritance Tax (IHT) sit in their own self-contained regime that frightens people far more than it should. The fear comes from the language — "principal charge", "proportionate charge", "effective rate" — not from the maths, which is just percentages applied in a fixed order. Below I walk through every charge a typical discretionary trust (the type HMRC calls a relevant property trust) can meet, with figures verified against current HMRC guidance.
Two things before we start. First, all the figures here use the nil-rate band of £325,000, which is frozen until 5 April 2031 (HMRC rates and allowances). Second, trust tax is genuinely one of the areas where a mistake is expensive and a TEP-qualified adviser earns their fee — treat this as a map of how the charges work, not a substitute for advice on your own trust.
The three IHT charges on a discretionary trust
A relevant property trust is exposed to IHT at three moments. Understanding which charge applies when is half the battle:
| Charge | When it bites | Maximum rate |
|---|---|---|
| Entry charge | When you settle assets above the nil-rate band into the trust during your lifetime | 20% |
| Principal (10-year) charge | On every 10th anniversary of the trust's creation | 6% |
| Exit charge | When capital leaves the trust between anniversaries (and, in a modified way, in the first 10 years) | 6% |
The design behind these numbers is deliberate. HMRC's intention is that property held in a relevant property trust should bear roughly the same IHT as if it passed down one generation under the 40% death rate — collected instead as a 20% entry charge plus a series of smaller charges over the trust's life (HMRC Inheritance Tax Manual, IHTM42087). Once you see that logic, the 6% maximum stops looking arbitrary.
The 20% entry charge — a £600,000 worked example
When you transfer assets into a discretionary trust in your lifetime, it is a chargeable lifetime transfer (CLT). If the value settled (after any reliefs and your available nil-rate band) exceeds £325,000, IHT is due immediately. Per HMRC's guidance on trusts and IHT: "If the trustees pay, the rate of tax is 20%."
Margaret, a widow, settles £600,000 of investments into a new discretionary trust for her grandchildren. She has made no other chargeable gifts in the previous seven years, so her full £325,000 nil-rate band is available, and the trustees agree to pay the tax.
- Value settled: £600,000
- Less available nil-rate band: −£325,000
- Chargeable amount: £275,000
- Entry charge at 20%: £275,000 × 20% = £55,000
The £55,000 entry charge is due, and because the trustees are paying it from trust funds (rather than Margaret paying personally), no "grossing up" is needed. The reduced rate of 20% — half the 40% death rate — is what makes lifetime trusts attractive compared with leaving the same assets to be taxed at death.
Two traps worth flagging. If Margaret had paid the tax herself rather than the trustees, the gift would be grossed up — her payment is itself a loss to her estate, so the effective rate climbs to 25% on the chargeable slice. And if she dies within seven years of making the transfer, the charge is recalculated at the full 40% death rate, with credit for the 20% already paid (gov.uk).
The 10-year (principal) charge — how the 6% cap really works
Every 10th anniversary, HMRC values the trust and applies a periodic charge. People hear "6%" and panic, but 6% is the maximum — the actual rate is almost always lower because of how it is built. The official method has several steps (IHTM42085 onwards); here is the shape of it:
- Notional transfer. Take the value of the relevant property the day before the anniversary.
- Notional tax at lifetime rates. Charge IHT at 20% on the value above the available nil-rate band.
- Effective rate. Divide that notional tax by the trust value to get an effective rate — which can never exceed 20%.
- Actual rate. Multiply the effective rate by 3/10 (30%). Because the effective rate caps at 20%, the actual rate caps at 20% × 30% = 6% (IHTM42087).
Margaret's trust reaches its 10th anniversary. The investments have grown and the relevant property is now worth £700,000. The nil-rate band available to the trust is still £325,000 (she made no chargeable transfers in the seven years before the trust started, and no capital has left the trust).
- Notional transfer: £700,000
- Less nil-rate band: £700,000 − £325,000 = £375,000 chargeable
- Notional tax at 20%: £375,000 × 20% = £75,000
- Effective rate: £75,000 ÷ £700,000 = 10.714%
- Actual rate: 10.714% × 3/10 = 3.214%
- 10-year charge: £700,000 × 3.214% = £22,500
Notice the actual rate (3.214%) is roughly half the 6% ceiling. The shortcut that gets you to the same answer here: the chargeable slice above the nil-rate band × 6%, i.e. £375,000 × 6% = £22,500. That shortcut only works when the assets were relevant property for the full 10 years and the nil-rate band is undiminished — otherwise you must run the full steps.
Because the nil-rate band is frozen at £325,000 while asset values drift upward, the effective rate on long-running trusts tends to creep toward the 6% ceiling over the decades. That slow climb is exactly why trustees keep these calculations under review rather than assuming the first anniversary's rate holds forever.
Exit charges — when capital leaves between anniversaries
If the trustees distribute capital to a beneficiary between two 10-year anniversaries, an exit charge (HMRC calls it a proportionate charge) applies. As gov.uk puts it, "Inheritance Tax is charged up to a maximum of 6% on assets…transferred out of a trust" (gov.uk). The word "proportionate" is the key: you take the rate set at the last 10-year charge and scale it down by how far through the decade you are.
The rate is the actual rate from the most recent principal charge, multiplied by the number of complete quarters (3-month periods) that have elapsed since that anniversary, divided by 40 (the number of quarters in 10 years).
Three years after the 10-year charge, Margaret's trustees distribute £100,000 to a grandchild for a house deposit. Three years is 12 complete quarters since the last anniversary.
- Actual rate from the last 10-year charge: 3.214%
- Proportion of the decade elapsed: 12 quarters ÷ 40 = 0.30
- Exit rate: 3.214% × 0.30 = 0.964%
- Exit charge: £100,000 × 0.964% = £964
Under £1,000 of tax on a £100,000 distribution — a long way from the 6% headline. The earlier in the decade capital leaves, the smaller the exit charge, because fewer quarters have run.
Two practical points. There is no exit charge in the first three months after the trust is created or after a 10-year anniversary (zero complete quarters means a zero rate). And exits in the very first 10 years use a different, slightly more involved calculation based on the trust's initial value rather than a previous anniversary — if your distribution falls in that window, get the rate confirmed before paying out.
Why a nil-rate-band discretionary trust still earns its keep
Since 2007, married couples and civil partners can transfer the unused nil-rate band of the first to die to the survivor — the transferable nil-rate band (TNRB), which can give the second estate up to two full nil-rate bands (gov.uk: passing on a home). That led many people to assume the old "nil-rate band discretionary trust" written into wills was now pointless. It often isn't. Reasons it remains useful:
- Asset protection and control. The TNRB hands the nil-rate band amount outright to the survivor. A discretionary trust instead ring-fences it — protected from a survivor's remarriage, divorce, creditors, or future care-fee assessments — while still benefiting them as a discretionary beneficiary.
- Generational planning. Trustees decide who receives what and when, which a simple "all to the survivor" gift cannot do.
- Capturing future growth outside the estate. Assets settled within the nil-rate band carry no entry charge, and growth accrues inside the trust rather than swelling the survivor's taxable estate.
- The residence nil-rate band interaction. The separate residence nil-rate band (£175,000, frozen to 2030) tapers away once an estate exceeds £2 million; using a trust to keep the survivor's estate below that cliff can preserve relief that a straight TNRB transfer would lose.
Because a nil-rate-band-sized settlement carries no entry charge (it is at or below £325,000), and a trust valued at or below the nil-rate band produces a 0% rate at the 10-year point, these trusts frequently run their whole life with little or no IHT — while delivering control and protection a TNRB transfer simply cannot. That trade-off, not tax saving alone, is why they survive.
- Settling above £325,000 into a discretionary trust triggers a 20% entry charge on the excess — £600,000 settled costs £55,000 when trustees pay.
- The 10-year charge is capped at 6% but is usually less: notional tax at 20% above the nil-rate band, converted to an effective rate, then × 3/10.
- Exit charges scale the last anniversary's rate by complete quarters ÷ 40 — so distributions early in the decade are taxed lightly.
- Nil-rate-band figures are frozen at £325,000 to 5 April 2031, so effective rates drift upward as asset values rise.
- Even after the TNRB, nil-rate-band discretionary trusts remain valuable for asset protection, control, and managing the £2m residence-relief taper.
Is the entry charge always 20%?
The 20% rate applies where the trustees pay the tax. If you (the settlor) pay it personally, the gift is "grossed up" because your payment is itself a transfer of value, lifting the effective rate to 25% on the chargeable slice. And if you die within seven years of the transfer, HMRC recalculates the charge at the 40% death rate with credit for the 20% already paid. See HMRC's trusts and IHT guidance.
How is the 6% maximum on the 10-year charge reached?
The effective rate is notional IHT (charged at the 20% lifetime rate on value above the nil-rate band) divided by the trust value, so it can never exceed 20%. The actual rate is that effective rate multiplied by 3/10 (30%). The ceiling is therefore 20% × 30% = 6% (HMRC IHTM42087). In practice most trusts pay well under 6%.
Do I pay an exit charge if I distribute capital straight after setting up the trust?
No exit charge arises in the first three months because zero complete quarters have elapsed. Beyond that, in the first 10 years the exit rate is based on the trust's initial value using a separate calculation; after the first 10-year anniversary it is the last anniversary's actual rate scaled by complete quarters ÷ 40.
What is the nil-rate band and is it changing?
The nil-rate band is £325,000 and is frozen until 5 April 2031. The separate residence nil-rate band is £175,000, frozen until April 2030 and tapered for estates over £2 million. Figures from HMRC rates and allowances.
Do these charges apply to every kind of trust?
The 20% entry charge, 10-year charge and exit charges apply to "relevant property" trusts — most discretionary trusts and many lifetime interest-in-possession trusts created on or after 22 March 2006. Bare trusts and certain trusts for disabled beneficiaries are treated differently. Confirm your trust's category before applying any of this.
Is a nil-rate-band discretionary trust pointless now the nil-rate band is transferable?
No. The transferable nil-rate band hands assets to the survivor outright; a discretionary trust ring-fences them for protection against remarriage, divorce, creditors and care-fee assessments, gives trustees control over who benefits and when, keeps future growth out of the survivor's estate, and can help manage the £2m residence-relief taper. The benefit is control and protection, not headline tax saving.
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Sources: HMRC — Trusts and Inheritance Tax · IHTM42085 / IHTM42087 (10-year charge calculation) · HMRC rates and allowances · gov.uk — Inheritance Tax. Figures current for the 2026–27 tax year.