Inheritance Tax (IHT) can be a significant burden on your estate, potentially reducing the value of the assets you wish to leave to your loved ones. In the UK, estates valued above the current threshold of £325,000 (known as the nil-rate band) may be subject to IHT at a rate of 40%. This is where trusts can play a vital role. Trusts are a powerful tool for estate and tax planning, offering flexibility, asset protection, and the potential to reduce your IHT liability.
In this article, we explore in detail how trusts can help with IHT planning, the types of trusts available, their benefits and limitations, and how to decide whether setting up a trust is right for you.
A trust is a legal arrangement where one or more individuals (called trustees) manage assets on behalf of others (called beneficiaries). The person who sets up the trust is known as the settlor. When assets are placed into a trust, they are owned by the trust itself, not the individual. This can have significant implications for how those assets are treated for IHT purposes.
Trusts are commonly used to:
Control and protect family assets
Manage assets for young or vulnerable beneficiaries
Pass on assets in a tax-efficient way
Ensure assets are used according to your wishes
Removing Assets from Your Estate When you transfer assets into a trust, and provided certain conditions are met, those assets may no longer be considered part of your estate for IHT purposes. This means their value may not be taxed upon your death.
Gifting with Conditions Trusts allow you to make gifts to loved ones but retain control over how and when those gifts are accessed. Unlike outright gifts, assets in a trust can be managed according to your wishes.
Minimising IHT Through the 7-Year Rule Gifts into some trusts, like bare trusts or discretionary trusts, can fall outside your estate if you survive for 7 years after making the gift. This can be a key IHT-saving strategy.
Utilising the Nil-Rate Band More Than Once With careful planning, you can set up multiple trusts over several years to take advantage of the nil-rate band multiple times.
Reducing Taxable Value Through Loan Trusts and Discounted Gift Trusts These are specialist planning tools that can allow you to receive income while reducing your estate’s taxable value.
Beneficiaries have an immediate and absolute right to the assets.
Treated as a Potentially Exempt Transfer (PET) for IHT.
No IHT if the settlor survives 7 years.
Simple and transparent, ideal for gifts to adult children or grandchildren.
One beneficiary receives income from the trust for life (a life tenant), while capital goes to others later.
Assets are generally included in the life tenant’s estate for IHT.
Useful for second marriages or when you want to provide for a spouse but protect assets for children.
Trustees decide who benefits, how, and when.
Assets not part of any individual’s estate.
Subject to 10-year and exit charges (up to 6%).
Offers flexibility and control.
Tailored for beneficiaries with disabilities or special needs.
Offers favourable tax treatment.
Allows support without affecting means-tested benefits.
While trusts can reduce IHT, they are not entirely tax-free. The following taxes may apply:
Initial Charge: If the value of the assets transferred into a discretionary trust exceeds the nil-rate band, a 20% IHT charge may apply.
Periodic (10-Year) Charge: Discretionary trusts are reviewed every 10 years, and a charge of up to 6% may apply on the value over the nil-rate band.
Exit Charge: A small charge when assets are distributed out of the trust.
Income Tax: Trust income may be taxed at higher rates, especially for discretionary trusts (up to 45%).
Capital Gains Tax (CGT): May apply when assets are sold within the trust, though trusts benefit from a separate CGT allowance.
At Breaking the Mould Accounting, we offer bespoke inheritance tax planning services, including advice on trust structures, tax implications, and long-term strategies to preserve your wealth.
Contact us today to book a free consultation and discover how we can help you secure your family’s financial future.