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Exit Charge

Also known as: Distribution Charge, Trust Exit Tax

Definition

An exit charge is an inheritance tax charge (up to 6% of the asset value) that trustees must pay when distributing money or assets from a discretionary trust to beneficiaries.

Understanding exit charges is crucial for anyone using discretionary trusts in estate planning, as miscalculating these charges can result in unexpected tax bills and HMRC penalties.

What Does Exit Charge Mean?

Exit charges are part of the three-tier inheritance tax regime for relevant property trusts (discretionary trusts) established under the Inheritance Tax Act 1984, Section 65. Alongside entry charges when assets enter the trust and periodic charges (ten-year anniversary charges), exit charges ensure that wealth held in discretionary trusts doesn't escape inheritance tax indefinitely. The maximum rate is 6% of the distributed value, though the actual charge is often lower depending on specific circumstances. HMRC uses the term "proportionate charge" on official forms, particularly form IHT100c which trustees must complete when reporting exit charges.

When trustees distribute assets from a discretionary trust to beneficiaries, the calculation method differs significantly before and after the trust's first ten-year anniversary. Before the first decade, the charge is based on the effective inheritance tax rate when the trust was created, taking into account the settlor's nil-rate band (currently £325,000, frozen until 2028) and any previous gifts made within seven years. After the first ten-year anniversary, the charge is based on the rate calculated at the most recent periodic charge. The rate is "proportionate"—calculated using the number of complete quarters since the trust's creation or the last ten-year charge. For example, James created a discretionary trust in 2012. After the first ten-year anniversary in 2022, when trustees distribute £100,000 to his son Michael in 2025, the exit charge is approximately £180 based on the periodic charge rate and time elapsed.

The widely cited rule that "there are no charges in the first 10 years" is an oversimplification that catches many trustees by surprise. While it's true that if no inheritance tax was payable when creating the trust, distributions in the first decade usually avoid exit charges, significant exceptions apply. If the settlor dies within seven years of creating the trust, a previously exempt potentially exempt transfer (PET) becomes chargeable, retroactively creating an entry charge that affects exit charge calculations. David created a discretionary trust in January 2023 with £400,000, claiming it as a PET with no immediate tax. When David died in March 2026, his PET became chargeable. The £400,000 gift minus the nil-rate band (£325,000) meant £75,000 was subject to inheritance tax, creating a retrospective entry charge. When trustees distributed £150,000 to David's granddaughter Lucy in July 2026, an exit charge applied despite being within ten years of creation. Transferable nil-rate bands from a deceased spouse can also create complexity, potentially increasing the trust's value before inheritance tax becomes payable. Similarly, if assets that qualified for business or agricultural property relief are distributed after the relief ceases to apply, exit charges may arise even in the first decade.

Trustees are legally responsible for calculating exit charges, completing form IHT100c, and paying the tax to HMRC within six months of the end of the month in which the distribution occurred. HMRC doesn't calculate these charges automatically—trustees must use HMRC worksheets (IHT100WS) and guidance (IHT113) to determine the correct amount. Failing to file or paying late results in penalties and interest charges. For complex trusts, particularly those involving transferable nil-rate bands or relief-qualifying assets, professional tax advice is typically necessary to ensure accurate calculations and avoid costly errors.

Common Questions

"When does an exit charge apply to a trust?" An exit charge applies when assets leave a relevant property trust through distribution to beneficiaries. The charge can be up to 6% of the asset value. No exit charge applies if the distribution occurs within the first three months of the trust's creation or within three months after a ten-year anniversary.

"Is it true there are no exit charges in the first 10 years of a trust?" This is a common oversimplification. If no inheritance tax was payable when the trust was created, there is usually no exit charge on distributions in the first 10 years. However, exceptions exist if the settlor dies within seven years, if transferable nil-rate bands apply, or if business or agricultural property relief no longer qualifies.

"How is an exit charge calculated on a discretionary trust?" The calculation depends on whether the exit occurs before or after the first ten-year anniversary. Before that anniversary, the charge is based on the effective rate when the trust was created. After the anniversary, it's based on the most recent periodic charge rate. The maximum charge is 6% of the distributed value.

Common Misconceptions

Myth: "Discretionary trusts have no inheritance tax charges in the first 10 years, so I can distribute assets freely without tax consequences."

Reality: While it's true that if no inheritance tax was paid when creating the trust, there are usually no exit charges on distributions in the first 10 years, this rule has significant exceptions. If the settlor dies within seven years of creating the trust (making a previously exempt gift chargeable), if transferable nil-rate bands are involved, or if assets that qualified for business or agricultural relief are distributed, exit charges may apply even in the first decade.

Myth: "Exit charges are automatically calculated and billed by HMRC, so trustees don't need to worry about reporting them."

Reality: Trustees are legally responsible for calculating exit charges, completing form IHT100c, and submitting it to HMRC within six months of the distribution. HMRC does not automatically calculate these charges. Failing to file or paying late can result in penalties and interest charges. For complex trusts, professional tax advice is typically necessary to calculate the charge correctly using HMRC worksheets IHT100WS and guidance IHT113.

  • Discretionary Trust: The primary type of trust subject to exit charges under the relevant property regime.
  • Relevant Property Trust: The technical category of trusts subject to exit charges, including discretionary trusts and certain accumulation trusts.
  • Periodic Charge: The ten-year anniversary charge that affects how exit charges are calculated after the first decade of a trust.
  • Inheritance Tax: The broader tax system within which exit charges operate as a specific charge on trust distributions.
  • Trust Taxation: The complete tax framework for discretionary trusts, including income tax, capital gains tax, and inheritance tax charges.
  • What Is a Trust? (And How Do They Work in Wills?)
  • Using Trusts to Protect Your Estate
  • Discretionary Trusts in Wills Explained: This article explains the complete taxation framework for discretionary trusts, including both periodic charges and exit charges.
  • Nil-Rate Band Discretionary Trusts: Transferable nil-rate bands can create complexity in exit charge calculations for this common type of discretionary trust.
  • Pilot Trusts for Inheritance Tax Planning: Understanding exit charges is crucial when distributing assets from pilot trusts while maintaining inheritance tax efficiency.

Need Help with Your Will?

If you're considering discretionary trusts in your will, understanding exit charges helps you make informed decisions about trust structures and their long-term tax implications for your beneficiaries.

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Legal Disclaimer:

This article provides general information only and does not constitute legal or financial advice. WUHLD is not a law firm and does not provide legal advice. Laws and guidance change and their application depends on your circumstances. For advice about your situation, consult a qualified solicitor or regulated professional. Unless stated otherwise, information relates to England and Wales.