Trusts and Inheritance Tax Explained

Trusts have a faintly Victorian ring to them, the stuff of landed estates and family fortunes, but in practice they are simply a legal arrangement for holding wealth on behalf of someone else, and they are used every day by ordinary families. Set up well, a trust can protect a vulnerable relative, ring-fence money for grandchildren, or hold a life policy so it pays out cleanly. Set up badly, it can create a tax charge that never needed to exist.

This guide explains what a trust really is, how the main types work, and crucially, how each is treated for inheritance tax under the 2026 rules. Trusts are one of the more technical corners of estate planning, so we keep the language plain and flag where professional advice matters. For the wider picture, our complete guide to inheritance tax planning sets the scene, and this guide goes a level deeper on trusts specifically.

What a trust actually is

A trust is a legal relationship between three roles. The settlor is the person who puts assets in. The trustees are the people who legally own and manage those assets, not for themselves, but under a strict duty to act in the interests of others. The beneficiaries are the people who ultimately benefit. The clever part is that a trust splits ownership in two: the trustees hold the legal title, while the beneficiaries hold the right to benefit.

That split is what makes trusts so useful. You can hand assets to trustees to look after, perhaps for a child who is too young to manage money, a relative who is vulnerable, or a grandchild whose education you want to fund, while a document called the trust deed sets out exactly what the trustees may and may not do. It is a way of giving without simply handing over a cheque and hoping for the best.

For inheritance tax, the point that matters is this: once assets are properly placed in most trusts, they usually leave your personal estate. They are no longer yours in the eyes of HMRC. But, and it is a significant but, many trusts then fall into their own separate tax regime, so the tax does not vanish; it simply changes shape.

Why trusts and inheritance tax are linked

Inheritance tax in the UK is charged at 40% on the value of your estate above your available allowances. Everyone has a nil-rate band of £325,000, and many also have a residence nil-rate band of up to £175,000 when a home passes to direct descendants, bands that are frozen until 2030. A married couple or civil partners can combine their allowances to pass on up to £1 million between them. Anything above that is potentially taxed at 40%.

Trusts entered the inheritance tax story because they were once a favourite way to sidestep that 40% charge. In 2006 the rules were tightened dramatically, and today most trusts you create in your lifetime are caught by what is called the “relevant property regime”. The upshot is that trusts are no longer a loophole: they are a legitimate planning tool with their own costs and charges, best judged on what they achieve beyond tax. If reducing the bill is your main aim, our guide on how to reduce inheritance tax legally covers the full toolkit.

The main types of trust

There is no single thing called “a trust”. The label covers a family of arrangements, each suited to a different job. The three you are most likely to meet in estate planning are bare trusts, discretionary trusts and interest-in-possession trusts.

A bare trust is the simplest: the beneficiary is nailed down from day one and can demand the assets at 18 (16 in Scotland). A discretionary trust is the most flexible, the trustees hold a pool of assets for a group of potential beneficiaries and decide who gets what, which is precisely why HMRC watches it most closely. An interest-in-possession trust sits between the two, typically giving one person the income (say, a surviving spouse) while preserving the capital for others (say, children from a first marriage).

How trusts are taxed for inheritance tax

For trusts inside the relevant property regime, which includes most discretionary trusts, there are three potential charge points. Understanding them is the key to understanding whether a trust actually helps.

• 1

  The entry charge

  When you place more than your available nil-rate band (£325,000, less any chargeable gifts in the previous seven years) into the trust, the excess suffers an immediate 20% charge, the lifetime rate, which is half the 40% death rate.

• 2

  The ten-yearly (periodic) charge

  On each tenth anniversary, the trust is assessed and pays up to 6% on the value above the available nil-rate band. In practice, because of how the sum is calculated, the effective rate is often well below 6%.

• 3

  The exit charge

  When assets leave the trust and pass to a beneficiary, a proportionate charge of up to 6% may apply for the time since the last ten-year anniversary.

The practical takeaway is that if you keep the value placed into a discretionary trust at or below your nil-rate band, you can often avoid the entry charge altogether, and the later charges stay modest. This is why families sometimes make gifts into trust every seven years, using a fresh nil-rate band each time. It is careful, patient planning, and easy to get wrong, which is why the sums repay a conversation with a specialist.

A trust versus an outright gift

The obvious alternative to a trust is simply to give money away directly. Both can remove value from your estate, but they behave very differently, and the choice usually comes down to control rather than tax alone.

If you simply want to help an adult child buy a home and you trust them completely, an outright gift under the gifting rules is usually cheaper and cleaner. A trust earns its keep when control and protection matter: a beneficiary who is young, disabled, financially naive, or going through a rocky relationship. That is the real question to ask: not “which saves more tax?” but “do I need to keep a hand on the tiller?”

When a trust makes sense

Despite the complexity, there are situations where a trust is close to the ideal tool. It is worth knowing them, because the right trust in the right circumstance can be transformative, and the wrong one is simply an expensive mistake.

• Providing for young children or grandchildren, so money is managed responsibly until they are old enough to handle it.
• Protecting a vulnerable or disabled beneficiary, where a specialist disabled person’s trust also carries favourable tax treatment.
• Second marriages, where you want to give a surviving spouse an income for life but ultimately pass capital to children from an earlier relationship.
• Holding a life insurance policy, so the payout lands outside your estate and reaches your family quickly, without waiting for probate.
• Ring-fencing assets against a beneficiary’s divorce, creditors or bankruptcy.

Notice how few of these are really about dodging the 40% charge. The tax treatment is something to manage, but the reason to act is usually protection and control. That framing keeps you out of trouble, trusts sold purely as tax-avoidance schemes are exactly the ones that attract HMRC’s attention and often fail.

Setting one up: the practical steps

Creating a trust is not a do-it-yourself job. A solicitor or a specialist adviser drafts the trust deed, appoints the trustees and registers the trust with HMRC’s Trust Registration Service, a legal requirement for almost all trusts today. From then on, the trustees are responsible for managing the assets, keeping records and dealing with any tax returns and charges.

Costs vary: a simple trust might be a few hundred pounds to establish, a more complex one several thousand, with ongoing fees for administration and, where relevant, investment management. Because the wrong structure can create tax rather than save it, this is an area where paying for good advice genuinely pays for itself. A regulated adviser will also weave the trust into your wider plan: your will, your pensions and your inheritance tax planning as a whole, rather than treating it in isolation.

Vetted Wealth is a concierge service, not an adviser: we match you, free of charge, with an independently vetted, FCA-regulated professional who can tell you whether a trust is right for your circumstances at all. Investments held in trust can fall as well as rise, and tax rules can change, so this guide is information rather than personal advice.

Common questions on inheritance tax