inheritance tax planning trusts

This article was last updated on 1 December 2021.  

Inheritance Tax Planning Trusts In 2021

This article explains all you need to know about inheritance tax planning trusts.

What is an inheritance tax planning trust?

You can set up a trust to help you manage what will happen to your estate after you pass away. This is an important part of thinking about your estate planning and how to avoid inheritance tax.

Not only can a trust help reduce the inheritance tax you and your beneficiaries will pay, but they are also a useful tool for asset protection and to give you flexibility in how you manage your finances. However, it is worth getting advice on setting up a trust.

This is because there are complex rules about setting up such a trust, otherwise, the trust arrangement can actually leave you with more tax to pay to HMRC.

Topics that you will find covered on this page

How do inheritance tax planning trusts work?

A person who establishes a trust is called the ‘settlor’. The settlor will nominate trustees, who hold the legal interest in the asset and then manage the trust on behalf of the beneficiaries.

Settlors are also often a trustee during their life. This arrangement will all be laid out in a trust deed.

For example, you could set up a trust to pay for a grandchild’s university education or for sustaining a disabled family member for life up to a certain age.

Why is less inheritance tax paid on trust property?

If you, your partner and children who are minors cannot benefit from the property and capital in the trust fund, the property is no longer considered part of your estate.

This is because technically, the assets are no longer in your hands, they belong to the trustees and beneficiaries.

This works as long as you live for over seven years after setting up the trust. If you pass away within 7 years of setting up the trust, you pay the full amount of IHT at 40%.

Here is a useful video about inheritance tax planning and trusts.

What are the different types of trust?

There are multiple types of trust you can set up when considering how to manage your estate.

When attempting to reduce inheritance tax on property and assets, most of these will have to be set up during your lifetime. It is important to do your research and get advice from legal advisers to prevent defeating the point and paying more tax.

Options include:

  • Bare trusts. This is the most basic form of trust, so one person holds the property on behalf of another, often a child. Bare trusts are often exempt transfers so you do not need to pay IHT. However, if you die under 7 years from creating the trust, tax will be charged as part of your estate.
  • Discretionary trust. This is the most common trust form. You transfer all the savings and assets to the trust, and the trustees get discretion as to how the trust is distributed between beneficiaries after your death, taking into account the settlor’s wishes. The advantage is that as the trust funds are separate, they are not charged as part of your estate.
  • Discounted gift trusts. Generally used for insurance bonds. You can get an income of up to 5% of the bond each year.
  • Interest in possession trustThis is where the beneficiary gets the income on the trust as it is generated. You may have to pay the 10-year iht charge on an interest possession trust. You also may have to pay income tax and cgt on the money you make off your investment.
  • Mixed trusts. This combines different elements of multiple types of trust, so they are specialised to your needs.
  • Trusts for a vulnerable person. This is to help manage the funds of a beneficiary who does not have the capacity to do it themself. There will generally be less tax liability on these.
  • Loan trusts. This is a form of investment where you lend out your assets to the trust. This means they still belong to you and are part of your estate. However, if you earn investments on your assets, they stay in the loan trust so when the taxman charges you property inheritance tax, the investment money is not included.

How much is the tax on inheritance UK?

When you die, an inheritance tax bill of up to 40% on your estate value over the nil rate band can be charged.

The nil rate band is your personal allowance which inheritance tax is not charged on. It is frozen at £325,000 until 2021.

Also, if your heirs are your direct descendants, i.e. your children and grandchildren, there is an additional residence nil rate band. At the moment this is £175,000. Therefore you will not pay inheritance tax on this sum also.

Further, there is a reduced inheritance rate of 36% if the individual leaves over 10% of their possessions to charity.

For more guidance on if inheritance tax is due, the government provides up to date advice and information:https://www.gov.uk/guidance/trusts-and-inheritance-tax

This link also provides you with the forms you need to declare your assets to be taxed: https://www.gov.uk/government/collections/inheritance-tax-forms

Can you set up a trust to avoid inheritance tax?

Yes. Trusts are not tax-free, however, as they have a different tax treatment to the rest of your estate.

Therefore, they are a viable option to reduce the inheritance tax bill you and your beneficiaries have to pay, therefore preserving family wealth.

You will avoid inheritance tax liability if you set up a trust 7 years or more before your death.

Why are inheritance tax trusts useful?

You may want to consider setting up a trust because otherwise, your beneficiaries could face a very large inheritance tax bill once you pass away. This may mean they have to sell property and investments etc.

By using inheritance tax planning trusts, you can ensure that your beneficiaries inherit the shares and assets you want them to, without facing a vast tax bill.

How do you set up a trust to avoid inheritance tax?

All adults with capacity can set up a trust, and there are many companies that can help you do this.

Couples can also set up a trust together to manage how the surviving spouse can remain in the family home but still allow the value of the property to be passed onto the younger generations.

You should consult a solicitor, wealth adviser, or accountant. Setting up a trust is a complex process, and if the steps are not done correctly, you could end up paying the taxman more money.

iht planning trusts

What is a ‘spouse exemption’?

When you die, under intestacy rules, your assets can pass to a spouse or civil partner without having to pay inheritance tax IHT.

However, when they die, they will still have to pay iht. Something to consider is that if you are in a couple, you can transfer your unused nil-rate band to the spouse who dies second, which means they have double the normal nil rate band.

Do you have to pay inheritance tax on a trust?

Yes. Many people think you do not have to pay any tax to pay on a trust- this is not true. You generally pay 20% IHT if the assets are over the nil rate band.

There are exemptions to this rule, like if you continue to benefit from the trust fund assets. In addition to inheritance tax, trustees must pay income tax and capital gains tax on income from the trust assets and any chargeable gains from the trust.

How do I decide what kind of trust is right for me and my family?

It is worth seeking legal advice to help with estate planning.

However, the most common type of trust is a discretionary trust, because you can change the beneficiaries.

This is helpful to safeguard your legacy where a beneficiary goes bankrupt or has a divorce. If your trust has a particular aim and you know who you want to benefit, you may want a bare trust, so beneficiaries have a right to the trust value.

What are the inheritance tax rules on a discretionary trust?

Most trusts will be discretionary, which means the trustees get some say in how trust assets are distributed.

When you set up the trust, you pay 20% charge on the value over the nil rate band, also called your personal allowance.

At present, the personal allowance is £325,000. Then, every 10 years, you pay 6% tax on the value of money in the tax over your personal allowance. Finally, when you close the tax or remove the assets in it, you pay an exit charge of 6%.

The rate of this tax charge is based on the most recent calculation at a 10 year anniversary, calculated on a pro-rata basis.

inheritance tax planning guide

How much does it cost to set up a trust to avoid inheritance tax?

It depends on the trust and the assets. On top of the 20% inheritance tax charge on assets over your personal allowance when setting up the trust, you will also have to pay legal costs.

This includes advice when establishing the trust, appointing professional trustees, and conveyancing charges whenever you transfer money in and out of the trust. It generally will cost over £1000 to set up a trust.

What is the 10 year charge on trusts?

Every 10 years, there will be a periodic tax payment on the money over the nil rate band. The maximum rate is 6%.

Interest in possession trusts will be liable to pay the 10-year inheritance tax charge.

What is the 10-year IHT charge discretionary trusts?

Trusts are not tax-free. If you have a discretionary trust, every 10 years you will have to pay a charge on the money in the trust in excess of £325,000. This charge at the moment is 6%.

What are the other ways I can avoid inheritance tax?

There are other legal ways to give money to beneficiaries and avoid paying IHT.

These include:

  • You can give a gift of up to £3000 and not face inheritance tax
  • You can give however many people you want £250 each
  • You can give your children £5000 as a wedding gift. Grandparents can give £2500. Anyone can gift £1000 in cash.
  • You can give as much as you want to charity or political parties
  • Other tax-free gits can be made, but they only fall outside your estate if you live seven years after you made the transfers. If you die within 7 years, and you have made gifts that are over the nil-rate band, then there will still be some tax relief. The tax reduces if the transfer was made 3-7 years before your death.
  • Through your pension. If you pass away before 75, then any retirement income left in a pension fund passes to your beneficiaries without you having to pay any tax on your retirement fund. If you are over 75, the inheritance will be taxed according to the beneficiaries’ marginal income tax band.
  • Life assurance can be used to pay an IHT bill.
inheritance tax trusts

Why would I set up a trust rather than making a gift to my children or grandchildren?

First, you can only make gifts of up to 3000 to children before there are tax consequences. Second, setting up a trust gives you more control as the settlor.

When you make a gift, you lose control over the assets, which is a problem if you are making a gift to someone under age 18 or if the beneficiary later gets a divorce or files for bankruptcy. If this happens, the assets will be used to pay their debts.

On the other hand, when you set up a trust, you choose your beneficiaries and as the settlor, you are likely to make yourself a trustee. You can select the beneficiaries and write a ‘letter of wishes’ for when you pass away.

How do I get legal advice to set up a trust?

Many lawyers and accountancy firms offer specialist knowledge to help you set up a trust. You may want to appoint the same solicitor as will handle your will and probate.

helping hand (1)

Need help deciding which type of Trust you should use for your circumstances?

Book a consultation below

Leave your details or call us now

Have a free consultation with a Trust specialist who can tell you how to achieve what you want in a legal way.

We offer a free consultation to discuss your circumstances and see what options you have:

  • regarding avoiding or mitigating your care fees 
  • how you can safely, and legally, pass your home and assets to your family
  • how to reduce your inheritance tax liability.

If you would like some help, please leave your details below and someone will be in touch.

Or you can call us now on  0333 567 1601


Leave us your details below

We work with with Quadrant Estate Planning for them to bring you their market leading later life planning support. 

Meet the author

Jane Parkinson

Jane Parkinson

Jane is one of our primary content writers and specialises in elder care. She has a degree in English language and literature from Manchester University and has been writing and reviewing products for a number of years.

Meet The Team

UK Care Guide - A trusted resource, as seen on:

Share this page

Share on facebook
Share on twitter
Share on email
Share on linkedin

Are you looking for help with setting up a Trust to protect your property and assets? Let us help you.

Leave your details here 

0333 567 1601