Trusts and Inheritance Tax: A Plain English Guide
Trusts can remove assets from your estate and reduce inheritance tax — but they come with their own tax charges, costs, and complexity. This guide explains how different types of trust work for IHT purposes, when they make sense, and when simpler alternatives may be better.
Important: Trust planning is complex and the wrong structure can create unintended tax consequences. This article is for educational purposes only. Always seek advice from a qualified solicitor and tax adviser before setting up a trust.
Trusts and IHT — Key Numbers
What Is a Trust?
A trust is a legal arrangement where one person (the settlor) transfers assets to be held and managed by others (the trustees) for the benefit of specified people (the beneficiaries).
Once assets are placed in a trust, they are legally owned by the trustees — not by you and not by the beneficiaries. This separation of ownership is what creates the potential IHT benefit: if you do not own the assets, they may not form part of your taxable estate.
The key parties in a trust are:
- Settlor: The person who creates the trust and transfers assets into it
- Trustees: The people (or organisations) who manage the trust assets according to the trust deed
- Beneficiaries: The people who benefit from the trust (either named individuals or a defined class)
How Trusts Reduce IHT
The basic principle is straightforward: assets held in a trust are generally outside the settlor's estate. If the trust is structured correctly, the assets are not subject to IHT when the settlor dies.
However, the reality is more nuanced. HMRC charges tax at several points to prevent trusts from being used as a simple IHT avoidance mechanism:
- On entry: When you put assets into certain types of trust, there may be an immediate tax charge
- Every 10 years: A periodic charge applies to the trust's value
- On exit: When assets leave the trust (e.g., distributed to beneficiaries), there may be an exit charge
The question is always whether the IHT saved by keeping assets out of your estate is greater than the combined trust charges over time.
Types of Trust
Bare (Absolute) Trust
In a bare trust, the beneficiaries have an absolute right to the trust assets. The trustees hold the assets on their behalf but have no discretion over how they are used.
For IHT purposes, transferring assets into a bare trust is treated as a potentially exempt transfer (PET). If the settlor survives seven years, the assets fall completely out of their estate. There are no periodic or exit charges.
Best for: Simple gifts to adult beneficiaries where you want the assets held by trustees rather than given outright (for example, for a young adult who may not be ready to manage a large sum).
Discretionary Trust
In a discretionary trust, the trustees have full discretion over who receives what, when, and how much. The settlor typically provides a “letter of wishes” to guide the trustees, but this is not legally binding.
Transferring assets into a discretionary trust is a chargeable lifetime transfer (CLT). If the transfer exceeds the settlor's available NRB (£325,000), there is an immediate entry charge of 20% on the excess. The trust also faces periodic charges every 10 years and exit charges when assets are distributed.
Best for: Families who want flexibility — for example, to protect assets from a beneficiary's divorce, provide for future grandchildren, or manage distributions based on changing needs.
Loan Trust
With a loan trust, you lend money to a trust (typically interest-free). The loan amount remains in your estate, but any growth on the invested amount sits outside it. You can demand repayment of the loan at any time, giving you access to your capital.
Best for: People who want to freeze the value of assets in their estate while allowing growth to benefit the next generation, without giving up access to their capital.
Discounted Gift Trust
You transfer a lump sum into a trust but retain the right to receive regular income payments from it. The “discount” — the difference between the amount transferred and the actuarial value of your retained income — is treated as a gift that leaves your estate immediately.
Best for: People who need ongoing income but want to reduce their estate. The discount can be substantial for older or less healthy individuals.
| Trust type | IHT treatment on entry | Periodic charges | Exit charges | Flexibility |
|---|---|---|---|---|
| Bare trust | PET (exempt after 7 years) | None | None | Low — fixed beneficiaries |
| Discretionary trust | CLT (20% above NRB) | Up to 6% every 10 years | Yes | High — trustees decide |
| Loan trust | No transfer (loan remains in estate) | On growth only | On growth only | Medium — can recall loan |
| Discounted gift trust | PET/CLT on discounted value | Varies | Varies | Low — income rights fixed |
Comparison of trust types for IHT planning
Trust Tax Charges Explained
Entry Charge
When you transfer assets into a discretionary trust above your available nil-rate band, the excess is charged at 20% (half the death rate of 40%). If you have made other chargeable transfers in the previous seven years, these reduce your available NRB.
| Component | Value |
|---|---|
| Amount transferred to discretionary trust | £500,000 |
| Less: available NRB | −£325,000 |
| Excess | £175,000 |
| Entry charge at 20% | £35,000 |
If the settlor dies within seven years, the trust may face additional tax at the death rate (40%) less credit for the 20% already paid.
10-Year Periodic Charge
Every 10 years from the date the trust was established, HMRC calculates a charge on the trust's value. The maximum rate is 6% of the value above the NRB, but the actual rate is usually lower due to the calculation method.
| Component | Value |
|---|---|
| Trust value at 10-year anniversary | £600,000 |
| Less: NRB | −£325,000 |
| Excess | £275,000 |
| Effective rate (max 6%) | £275,000 × 6% = £16,500 |
Simplified — actual calculation depends on settlor's cumulative transfers
Exit Charge
When assets leave the trust (distributed to beneficiaries), an exit charge applies. This is calculated proportionately based on the time since the last periodic charge and the rate that applied at that charge. The charge ensures assets cannot avoid the periodic charge by being distributed just before an anniversary.
When Is a Trust the Right Tool?
Trusts make most sense when:
- Your estate is significantly above the IHT threshold — the larger the estate, the greater the potential saving that justifies the trust costs
- You want to protect vulnerable beneficiaries — for example, a beneficiary with a disability, addiction issues, or who is at risk of financial exploitation
- You want flexibility over distribution — discretionary trusts let you adapt to changing family circumstances
- You want to freeze estate value — loan trusts and discounted gift trusts can keep future growth outside your estate while maintaining access to capital or income
- You want to hold life insurance outside your estate — see our guide on life insurance in trust
Trusts vs Other Approaches
Trusts are not always the best option. Here is how they compare with simpler alternatives:
| Approach | IHT benefit | Complexity | Cost | Best for |
|---|---|---|---|---|
| Outright gifts (PETs) | Exempt after 7 years | Low | Nil | Simple estates, healthy donors |
| Annual exemptions | Immediately exempt | Very low | Nil | Regular small gifts |
| Normal expenditure from income | Immediately exempt | Low (record-keeping needed) | Nil | Retirees with surplus income |
| Bare trust | PET — exempt after 7 years | Low-medium | £500–£1,000 | Young beneficiaries |
| Discretionary trust | Removed from estate (with charges) | High | £1,000–£3,000+ | Complex families, large estates |
| Loan trust | Growth outside estate | Medium | £1,000–£2,000 | Capital access needed |
| Charity donation | Immediately exempt + 36% rate | Low | Nil | Philanthropic intent |
Comparing IHT planning approaches
For many families, a combination of gifting exemptions, normal expenditure from income, and outright PETs will be simpler, cheaper, and equally effective. Trusts add value when you need control, flexibility, or protection that outright gifts cannot provide.
Frequently Asked Questions
Do trusts still reduce inheritance tax in the UK?
Yes, trusts can still reduce IHT by removing assets from your estate, but they are not a free pass. Discretionary trusts face entry charges (20% above the NRB), periodic charges every 10 years (up to 6%), and exit charges when assets leave the trust. The IHT saving must outweigh these costs for a trust to be worthwhile.
How much does it cost to set up a trust?
A simple bare trust can cost as little as £500–£1,000 in solicitor fees. A discretionary trust typically costs £1,000–£3,000 to establish. Ongoing administration costs (accounts, tax returns, trustee meetings) can add £500–£2,000 per year depending on complexity.
What is the 10-year periodic charge on trusts?
Every 10 years from the date the trust was created, HMRC charges up to 6% of the trust's value above the nil-rate band (£325,000). The actual rate depends on how much of the settlor's NRB was used when assets were put into trust and any previous chargeable transfers.
Can I be a trustee of my own trust?
Yes, you can be a trustee, but you should not be the sole trustee and you must not benefit from the trust yourself or it may be treated as a 'gift with reservation of benefit' — meaning the assets remain in your estate for IHT purposes. Having independent co-trustees is strongly recommended.
What is the difference between a bare trust and a discretionary trust for IHT?
A bare trust has fixed beneficiaries with absolute rights — assets placed in a bare trust are treated as potentially exempt transfers (PETs) and fall out of the settlor's estate after seven years. A discretionary trust gives trustees flexibility over who benefits, but assets are chargeable lifetime transfers (CLTs) with an immediate 20% entry charge above the NRB, plus periodic and exit charges.
Should I use a trust to avoid inheritance tax?
It depends on your circumstances. Trusts are most effective for people with estates significantly above the IHT threshold who want to remove assets while retaining some control, protect vulnerable beneficiaries, or manage how wealth is distributed. For simpler situations, outright gifts may be more cost-effective. Always take professional advice.
Disclaimer: Trust law is complex and the tax consequences depend on your individual circumstances. This article provides general information only and should not be relied upon as legal or tax advice. Always consult a qualified solicitor and tax adviser before setting up a trust.
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