The £500 Trust Allowance: Why Everything After That Gets Taxed at 45%

Understanding the cliff edge in trust taxation that catches most trustees by surprise

A trustee showed me her trust’s tax calculation last week. The accountant had worked out the liability correctly, but she was still confused.

“I thought trusts got taxed like individuals,” she said. “Where’s the personal allowance? Where are the tax bands?”

This is the conversation I have repeatedly. Trust taxation looks nothing like personal taxation, and the difference costs families thousands of pounds every year.

The £500 Threshold

Since April 2024, UK discretionary trusts operate under a simple but punishing rule: if the trust’s income exceeds £500 in a tax year, all of that income becomes taxable at trust rates.

Not the excess over £500. All of it.

A trust with £400 of income pays no tax and doesn’t need to file a return.

A trust with £600 of income pays tax on the full £600 at 45% for interest and rental income, or 39.35% for dividends.

That’s not a typo. Cross the £500 threshold by even a pound, and the entire income becomes taxable at the highest rates in the UK tax system.

Why 45%?

The rate applicable to trusts (often called “RAT” in professional circles, which feels appropriate) exists to prevent people from using trusts to avoid higher-rate tax. The logic goes: if trusts paid tax at basic rates, high earners would simply transfer assets into trusts and extract the income at lower rates.

So trusts pay tax at the additional rate — the same rate that applies to individuals earning over £125,140.

For discretionary trusts, the rates are: 45% on savings income (bank interest, bond interest); 45% on rental income and other non-savings income; and 39.35% on dividend income.

There’s no personal allowance. No starting rate for savings. No dividend allowance. No progression through tax bands.

From the first pound above £500, trusts pay the highest rate.

The Change That Made It Worse

Before April 2024, discretionary trusts had a £1,000 “standard rate band” where income was taxed at basic rates (20% or 8.75% for dividends). Only income above £1,000 faced the full trust rates.

That band was abolished.

The practical impact is significant. Consider a trust receiving £900 in interest annually:

Before April 2024: £900 × 20% = £180 tax

After April 2024: £900 × 45% = £405 tax

Same income. More than double the tax.

For larger trusts, the numbers become more striking. A trust with £50,000 of investment income now faces a tax bill of £22,500 (at 45%), compared to an individual who might pay half that depending on their personal circumstances.

The Multiple Trust Rule

The £500 threshold gets even more restrictive when the same settlor (the person who created the trust) has established multiple trusts.

The £500 is divided equally between all trusts created by the same person, with a minimum of £100 per trust.

If your parents set up three separate trusts for three grandchildren, each trust gets a £166 threshold, not £500. If they created five or more trusts, each gets the minimum £100.

Certain trusts are excluded from this calculation, including vulnerable beneficiary trusts and interest in possession trusts, but standard discretionary trusts all share the threshold.

What 45% Really Costs — And What Trustees Often Miss

The 45% rate creates a significant drag on trust investments. Consider a trust holding £500,000, generating 4% annual income: that’s £20,000 of income, with approximately £8,400 going to HMRC each year at a blended rate.

Over ten years, that’s roughly £84,000 paid in tax. That number catches people’s attention — and rightly so.

But here’s what many trustees don’t realise: the 45% rate isn’t always the end of the story.

When trustees distribute income to a beneficiary, that income carries a 45% tax credit. The beneficiary is treated as having received the gross amount with tax already paid at 45%. If the beneficiary pays tax at a lower rate — or pays no tax at all — they can reclaim the difference from HMRC.

For a non-taxpayer beneficiary, that means reclaiming the entire 45%. For a basic-rate taxpayer, the reclaim is 25% of the gross distribution. Even a higher-rate taxpayer can reclaim 5%. (Source: HMRC guidance on Trusts and Income Tax, GOV.UK; Quilter technical insight on Taxation of income in discretionary trusts.)

So does that mean the £84,000 doesn’t matter? Not quite. There are important caveats:

The tax pool must cover the credit.

Trustees can only provide tax credits to beneficiaries if there’s sufficient tax in the trust’s “tax pool” — a running record of tax actually paid. If the pool runs short, trustees must top it up from other trust assets. (Source: HMRC guidance, GOV.UK.)

Cash flow matters. Even where reclaims are available, the money sits with HMRC until the beneficiary files their return and receives the refund. That could be months or even years after the tax was paid. In the meantime, the trust has less capital working for the beneficiaries.

Accumulated income is different. If income accumulates in the trust and is never distributed to beneficiaries, the 45% tax is paid and stays paid. There’s no reclaim. The tax pool only matters when distributions are actually made.

The real cost of the 45% rate depends entirely on the trust’s circumstances: who the beneficiaries are, what tax they pay, when (and whether) income is distributed, and how the trust’s investments are structured. It’s rarely as simple as the headline number suggests — in either direction.

The Vulnerable Beneficiary Exception

There’s one significant exception to the 45% rule.

If the trust qualifies as a “vulnerable beneficiary trust” under HMRC’s rules, and trustees make an annual election, the trust’s income can be taxed as if it belonged to the beneficiary instead.

For a beneficiary with no other income, this can mean paying little or no tax on trust income, rather than 45%.

The election must be made each year, by 31 January following the end of the tax year. Miss the deadline, and you’ve missed the benefit for that year entirely.

I’ve met trustees who’ve been paying 45% tax for years without knowing this election existed. The unnecessary tax paid? Tens of thousands of pounds that should have been supporting a vulnerable person.

Why This Matters

Trust taxation is designed to be harsh. The 45% rate exists specifically to discourage people from using trusts purely for tax avoidance.

But for trusts that exist for genuine reasons — to protect vulnerable beneficiaries, to manage inheritance for young people, to ensure long-term financial security — the tax system can feel punitive rather than fair.

The interaction between the 45% trust rate, the tax pool, beneficiary reclaims, and the structure of trust investments is where the real planning opportunities sit. Getting this right can mean the difference between a trust that works efficiently for its beneficiaries and one that slowly bleeds capital to HMRC.

That’s not something a blog post can solve. Every trust is different: different beneficiaries, different assets, different objectives. The right approach depends entirely on the specific circumstances.

But understanding the starting point — £500, then 45% — is the first step. What you do about it is the conversation worth having.

The Financial Conduct Authority does not regulate Trusts. The tax rates and thresholds mentioned are correct as of the 2024–25 tax year but may change. Sources referenced include HMRC guidance on Trusts and Income Tax (GOV.UK) and Quilter’s technical insight on Taxation of income in discretionary trusts. Professional advice should be sought for your specific circumstances.