Using a trust to cut your Inheritance Tax

When you put money or property in a trust, provided certain conditions are satisfied, you don’t own it any more. This means it might not count towards your Inheritance Tax bill when you die. This guide explains the ins and outs of using a trust to cut your Inheritance Tax.

What is a trust?

A trust is a legal arrangement where you give cash, property or investments to someone else so they can look after them for the benefit of a third person.

So, for example, you could put some of your savings aside in a trust for your children.

There are two important roles in any trust that you should understand before you read on.

  • The trustee is the person who owns the assets in the trust. They have the same powers a person would have to buy, sell and invest their own property. It’s the trustees’ job to run the trust and manage the trust property responsibly.
  • The beneficiary is the person who the trust is set up for and is usually unable to manage the trust assets for themselves either because they are too young or because they are not good at managing their own money. The assets held in trust are held for the beneficiary’s’ benefit.

What does a trust do?

Take advice

A trust can be a great way to cut the tax you’ll pay on your inheritance, but you need professional advice to get it right. Always talk to a solicitor.

If you put things into a trust then, provided certain conditions are met, they no longer belong to you.

This means that when you die their value normally won’t be counted when your Inheritance Tax bill is worked out.

Instead, the cash, investments or property belong to the trust. In other words, once the property is held in trust, it’s outside of anyone’s estate for inheritance tax purposes.

Another potential advantage is that a trust is a means of retaining control and asset protection for the beneficiary; a trust avoids handing over valuable property, cash or investment whilst the beneficiaries are still relatively young or vulnerable.

The trustees have a legal duty to look after and manage the trust assets for the person who will benefit from the trust in the end.

When you set up a trust you decide the rules about how it’s managed. For example, you could say that your children will only get access to their trust when they turn 25.

What types of trust are there?

There are several types of trust.

Some you can write into your will, while others you can set up right now.

Some trusts are subject to their own inheritance tax regimes and once assets have successfully been transferred into trust, they are no longer subject to inheritance tax on your death.

Others pay income and capital gains tax at higher rates, so it is important to know what type of trust you have.

The kind of trust you choose depends on what you want it to do. Here are some of the most common options:

  • Bare trust – the simplest kind of trust, a bare trust just gives everything to the beneficiary straight away (as long as they’re over 18).
  • Interest in possession trust – the beneficiary can get income from the trust straight away, but doesn’t have a right to the cash, property or investments that generate that income. The beneficiary will need to pay income tax on the income received. You could set up this kind of trust for your partner, with the understanding that when they die the investments in the trust will pass to your children. This is a popular trust structure used in wills for people who remarry, but have children from their first marriage.
  • Discretionary trust – the trustees have absolute power to decide how the assets in the trust are distributed. You could set up this kind of trust for your grandchildren and leave it to the trustees (who could be the grandchildren’s parents) to decide how to divide the income and capital between the grandchildren. The trustees will have the power to make investment decisions on behalf of the trust.
  • Mixed trust – combines elements from different kinds of trusts. For example, a beneficiary might have an interest in possession in (ie a right to the income of) half of the trust fund and the remaining half of the trust fund could be held on discretionary trust.
  • Trust for a vulnerable person – if the only one who benefits from the trust is a vulnerable person (for example, someone with a disability or an orphaned child) then there’s usually less tax to pay on income and profits from the trust.
  • Non-resident trust – a trust where all the trustees are resident outside the UK. This can sometimes mean the trustees pay no tax or a reduced amount of tax on income from the trust.

Want to set up a trust?

You can set up a trust right now or write one into your will.

When you set up a trust you need to clearly state:

  • What the assets of the trust are
  • Who the trustee and beneficiaries are
  • When the trust becomes active - is it immediately, or only when you die?

Many people who set up a trust in their will name the executor of the will as the trustee, but you don’t have to do this.

Read our guide on Choosing your executor

Need more advice?

Trust law is complicated and if you’re not careful you can walk into an immediate tax charge when setting it up.

To make sure you get things right, it’s vital to get professional advice before setting up a trust. Always talk to a solicitor.

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