Understanding Trusts and Inheritance Tax

With UK Inheritance Tax (IHT) rules constantly shifting and assets increasingly at risk of hefty taxation, proactive estate planning is essential for anyone wishing to leave behind something substantial. Trusts provide a flexible, powerful mechanism to protect family wealth and ensure your wishes are honoured, while potentially reducing the IHT burden.

This guide breaks down the fundamentals of trusts, strategic use for IHT mitigation, threshold changes and the practical steps to set one up.

The Fundamentals of Trusts: A Working Definition

At its simplest, a trust is a legal arrangement where one party (the settlor) transfers assets (cash, property or investments) into a structure managed by trustees for the benefit of beneficiaries.

• Settlor: the person who creates the trust and contributes assets.
• Trustee: an individual or corporate entity responsible for managing trust assets in accordance with the trust deed and fiduciary duties.
• Beneficiary: the person(s) or organisation(s) entitled to benefit from the trust, whether immediately or at a future date.

Assets held in trust are legally separate from the settlor’s personal estate, offering protection from creditors, divorce claims or unforeseen financial difficulties. Different trust types (discretionary, interest-in-possession or bare trusts) offer varying degrees of control and flexibility.

Strategic Planning: Trusts and IHT Mitigation

Trusts can be a cornerstone of wealth management and financial advice, enabling tailored estate strategies that reflect family circumstances and long-term goals. Two key concepts in IHT planning are:

• Potentially Exempt Transfers (PETs): gifts into certain trusts are free of IHT if the settlor lives for seven years after making the gift (the “seven-year rule”).
• Chargeable Lifetime Transfers (CLTs): larger gifts into trusts (exceeding nil-rate allowances) incur an immediate IHT charge at up to 20%, with further charges on exit or tenth anniversaries.

By choosing the right trust structure (such as a discretionary trust for maximum flexibility or an interest-in-possession trust to grant beneficiaries immediate income rights) you can optimise tax reliefs and retain control over asset distribution.

Navigating Inheritance Tax Thresholds and Recent Changes

Current UK IHT allowances comprise:

• Nil-rate band: £325,000 per individual.
• Residence nil-rate band: up to an additional £175,000 when a primary residence passes to direct descendants.

New domicile and deemed-domicile rules introduced in April 2025 reshaped how overseas assets are taxed. Long-term UK residents (formerly non-domiciled) may now be treated as UK-domiciled for IHT, meaning worldwide assets fall within the IHT net. This change amplifies the need for trusts to shield international wealth.

Practicalities and Considerations: Setting Up and Managing a Trust

Establishing a trust involves several critical steps:

1. Drafting a robust trust deed: clearly defines the settlor’s intentions, trustee powers and beneficiary rights.
2. Selecting trustees: choose individuals or professional trustees with the expertise, impartiality and reliability to manage assets over potentially decades.
3. Transferring assets: ensure valuations are accurate and tax returns filed promptly to secure initial reliefs.
4. Ongoing administration: trustees must keep detailed records, file IHT returns on chargeable events and review the trust in light of legislative changes.

Regular reviews, at least every three to five years, help adapt to evolving family needs, tax laws and financial markets. Trustees should work closely with solicitors, accountants and wealth management and financial advice specialists to maintain compliance and efficiency.