Ministers want to see "social tariffs" based on ability to pay, as part of a broader drive to reduce utility bills.
An estimated 2.4 million households have trouble paying their water bills, which cost an average of Â£376 a year.
Water companies will be asked to select the customers who are most at risk and offer them a discount.
They are currently bound by regulator Ofwat's licensing conditions which means they cannot cut bills without contravening the law.
The government guidance, developed following a consultation by the Department for Environment, Food and Rural Affairs, will allow them to make cuts.
Deputy Prime Minister Nick Clegg said: "If you're struggling to make ends meet, not paying for essential utilities isn't an option but it can mean making tough choices elsewhere; like sacrificing healthy meals for the family or new school books.
"We've already announced tough new measures to see gas and electric bills fall by up to Â£100 a year. This will see struggling families save more."
Environment Secretary Caroline Spelman said: " Water companies now have the chance to work with their customers to find a solution that works for them - and I hope to see that solution in place as soon as possible."
Water companies are also expected to support vulnerable customers with advice on how to use water more efficiently, guidance on whether installing a water meter could save them money and referrals to debt and benefits advice.