Trusts to Reduce Inheritance Tax: Common Mistakes to Avoid

For high-net-worth individuals (HNWIs) and business owners in the UK, wealth preservation and minimising estate taxes are often top priorities. One of the most effective tools for achieving these goals is the use of trusts. Trusts offer powerful asset protection, tax reduction benefits, and can help ensure a smoother transfer of wealth across generations. In this guide, we’ll explore how trusts work, the various types of trusts available, and how they can help reduce estate tax liabilities in the UK.

Do trusts avoid inheritance tax?

Not automatically. A trust can take assets, and their future growth, out of your estate, but most gifts into trust are chargeable lifetime transfers:

• 20% IHT is payable straight away on any value above your available nil-rate band (£325,000, less any chargeable gifts in the previous seven years).
• If you die within seven years, the gift is taxed again at up to 40%, with credit for the 20% already paid.
• Discretionary trusts pay a charge of up to 6% every ten years and when assets leave the trust.
• You must not be able to benefit from the trust, or the assets stay in your estate.

Gifts into a bare trust are the exception: they are potentially exempt transfers, with no IHT if you survive seven years. Used within these limits, trusts remain one of the most effective ways to pass on wealth.

What Is a Trust?

A trust is a legal arrangement where a settlor transfers assets to a trustee, who then manages those assets on behalf of one or more beneficiaries. Trusts can serve various purposes, including protecting assets, managing wealth, and minimising inheritance tax (IHT). Placing assets into a trust often protects them from creditors and typically avoids probate, helping maintain privacy when transferring wealth.

For a deeper dive into the basics of trusts and how settlors, trustees, and beneficiaries interact, watch our full breakdown here: Settlors, trustees and beneficiaries - ALL ABOUT TRUSTS!

How Trusts Minimise Estate Taxes in the UK

In the UK, inheritance tax (IHT) is a key concern for HNWIs. The standard rate for IHT is 40% on the value of the estate above the nil-rate band of £325,000. However, trusts can provide an effective way to minimise IHT liability and protect wealth from tax erosion. For a detailed explanation of inheritance tax and trusts, watch Inheritance tax and trusts - Part 4/4.

Here are some ways trusts can reduce estate taxes:

• Reducing the Taxable Estate: By placing assets into an irrevocable trust, these assets normally stop being part of the settlor’s estate for IHT, provided the settlor cannot benefit from the trust and survives for seven years. If you can still benefit, the gift with reservation rules treat the assets as still yours.
• Lifetime Gifts and Exemptions: When gifting assets to a trust, the settlor can use the £3,000 annual exemption, but most gifts into trust are chargeable lifetime transfers, not potentially exempt transfers (PETs). 20% IHT is due straight away on any amount above your available nil-rate band (£325,000), and more may be due if you die within seven years. Gifts into a bare trust are the main exception: they are PETs, free of IHT if you survive seven years.
• Transfers of Business Assets: Business Relief (BR) can take qualifying business assets out of IHT. From 6 April 2026, 100% relief applies to the first £2.5 million of combined business and agricultural property per person, with 50% relief above that. Trusts have their own separate £2.5 million allowance, and trusts set up by the same settlor on or after 30 October 2024 share one allowance between them. Trusts can be used to transfer family businesses or shares in a private company while benefiting from BR.
• Inheritance Tax Reliefs: Trusts can be structured to utilise various reliefs, such as Agricultural Property Relief (APR) or Business Relief (BR), to reduce the taxable value of business and agricultural assets in the estate.

Types of Trusts in the UK

UK individuals and families commonly use several types of trusts to protect assets, manage wealth, and reduce estate tax liabilities. The right type of trust depends on your financial goals and family dynamics.

Bare Trusts (Simple Trusts)

In a bare trust, the beneficiary has an absolute right to the assets within the trust. For tax purposes, HMRC treats the assets as though they belong to the beneficiary, making them liable for income tax and capital gains tax. People often use bare trusts to gift assets to children or grandchildren, providing a straightforward inheritance solution.

Discretionary Trusts

A discretionary trust gives the trustee full discretion over when and how to distribute assets to beneficiaries. This flexibility makes discretionary trusts ideal for managing family wealth, particularly where beneficiaries’ needs may change over time. However, discretionary trusts are subject to higher tax rates, including a 10-yearly charge and a potential IHT charge on distributions.

Interest in Possession Trusts

An interest in possession trust lets a beneficiary receive income for life, with capital passing to another beneficiary after death. It often supports a surviving spouse while ensuring the capital later goes to children or other intended beneficiaries.

Trusts for Business Assets

For business owners, trusts can be used to transfer family businesses, shares, or agricultural assets while minimising IHT through Business Relief (BR) or Agricultural Property Relief (APR). This is particularly beneficial for families wishing to pass on the family business to the next generation, although from 6 April 2026 full relief is limited to the first £2.5 million per person, with 50% relief above that.

Charitable Trusts

A charitable trust is designed to benefit one or more charitable organisations. Gifts to charity through a trust can reduce the taxable value of the estate, as charitable donations are exempt from IHT. This allows HNWIs to leave a charitable legacy while also receiving tax relief.

If you would like a quick visual guide to the types of trusts available in the UK, check the video below:

Watch the video on YouTube

Benefits of Using Trusts for Asset Protection in the UK

Trusts offer various benefits beyond IHT minimisation, making them a popular choice for high-net-worth individuals looking to protect their wealth.

• Protection from Creditors: Irrevocable trusts offer asset protection, as assets placed in a trust are generally protected from creditors, lawsuits, or divorce settlements. This is especially important for individuals in business or high-risk professions.
• Privacy and Avoiding Probate: Since assets in a trust do not go through probate, the details of the estate and distribution of assets remain private. This can be important for those seeking to maintain confidentiality.
• Control Over Distribution: Trusts offer the ability to control how and when assets are distributed. For example, a trust can set conditions based on age, milestones (e.g., graduating from university), or health needs, ensuring that beneficiaries receive assets when they are ready.

Key Considerations When Setting Up a Trust in the UK

It’s crucial to appoint the right trustee. Learn more about trustee responsibilities and HMRC registration requirements in our Trustees! Nearly ALL trusts must register with HMRC video.

Before setting up a trust, it’s important to consider several factors to ensure it aligns with your long-term goals:

• Choosing the Right Trustee: The trustee is responsible for managing and distributing the assets in the trust. Trustees can be individuals, family members, or professional institutions. It is important to choose a trustee with the experience and impartiality needed to carry out the trust's terms effectively.
• Tax Implications: Trusts in the UK are subject to income tax, capital gains tax, and potentially inheritance tax, so it is vital to work with a professional advisor to ensure the trust is structured efficiently and in compliance with UK tax laws.
• Ongoing Administration: Trusts require regular administration, including filing tax returns and keeping detailed records. Trustees must ensure they are fulfilling their legal duties and complying with all relevant tax laws. Trustees must also consider income tax and capital gains tax implications. For more information, view Income Tax and Capital Gains Tax on Trusts.

Common Mistakes to Avoid with Trusts and Inheritance Tax

1. Assuming a gift into trust is a PET. Most gifts into trust are chargeable lifetime transfers, so 20% IHT is due straight away on value above the nil-rate band.
2. Forgetting earlier gifts. Chargeable gifts in the previous seven years use up the nil-rate band first, so a trust that looks "within the band" can still trigger a 20% charge.
3. Keeping a benefit. If you can still use the assets (for example, you carry on living rent-free in a house you put into trust), they stay in your estate.
4. Ignoring the running costs. Discretionary trusts face ten-yearly and exit charges of up to 6%, and trustees pay income tax at up to 45% and capital gains tax at 24%.
5. Missing holdover relief. A gift of shares or property into a discretionary trust is a disposal for CGT, but holdover relief can usually defer the gain if it is claimed.
6. Not registering the trust. Most UK express trusts must be registered on HMRC's Trust Registration Service within 90 days of being set up.
7. Assuming business assets are fully covered. Business Relief now gives 100% relief only on the first £2.5 million per person, while trusts have a separate £2.5 million allowance that is shared by all trusts the same settlor sets up on or after 30 October 2024.

Trusts and Inheritance Tax: FAQs

Does a trust avoid inheritance tax?

A trust can reduce inheritance tax, but it rarely avoids it completely. Most gifts into trust are chargeable lifetime transfers: 20% is due straight away on value above your available nil-rate band of £325,000, and more may be due if you die within seven years. Once the assets are in the trust, they and their future growth are normally outside your estate, provided you cannot benefit. Discretionary trusts then pay their own charges of up to 6% every ten years.

How do trusts avoid inheritance tax?

They work by moving assets, and especially their future growth, out of your estate while trustees keep control. A couple can each put up to £325,000 into a discretionary trust every seven years without an immediate charge, if they have made no other chargeable gifts. Growth after the gift accrues inside the trust, not in your estate. Business and agricultural property can go in with relief, within the £2.5 million allowance from 6 April 2026.

Are trusts subject to inheritance tax?

Yes. Most trusts are within their own inheritance tax regime. There can be a 20% charge when assets go in (above the nil-rate band), a charge of up to 6% every ten years on the trust's value, and an exit charge when assets leave. Bare trusts are different: the assets are treated as the beneficiary's, so they form part of the beneficiary's estate instead. Trusts must also be registered with HMRC and pay income tax and capital gains tax.

What is the best trust to avoid inheritance tax?

There is no single best trust. A discretionary trust gives the most flexibility and protection, but gifts above the nil-rate band face a 20% entry charge. A bare trust gift is a potentially exempt transfer, so there is no entry charge, but the beneficiary is entitled to the assets at 18. Life insurance written in trust, and trusts holding business property within the £2.5 million relief, are also common. The right choice depends on your estate, your family and how much control you want to keep.

Can a living trust avoid inheritance tax in the UK?

"Living trust" is mainly a US term. In the UK, a trust you set up during your lifetime is a lifetime settlement, and it only reduces inheritance tax if you give up the assets for good. If you can still benefit, for example as a trustee who can pay money back to yourself, the gift with reservation rules keep the assets in your estate. A revocable trust you control does not save UK inheritance tax.

Conclusion

Trusts offer a smart way for UK high-net-worth individuals to protect assets, reduce taxes, and plan for the future. By transferring assets into a trust, you can lower inheritance tax, support loved ones, and preserve wealth across generations.

To do this effectively, work with an experienced inheritance tax advisor who can align the strategy with your financial goals. When structured well, trusts simplify estate planning, reduce tax burdens, and help you leave a meaningful legacy for your family.

You may also find it helpful to compare trusts to other estate planning vehicles by reading Trusts vs Family Investment Companies: Which is Right for You?, or discover how trustees can actively manage Inheritance Tax in the UK to benefit beneficiaries.

At ASWATAX, we specialise in helping UK-based high-net-worth individuals and business owners protect their wealth through expertly structured trusts and strategic estate planning. Don’t leave your legacy to chance our experienced advisors will work closely with you to reduce inheritance tax exposure, safeguard your assets, and ensure your family’s future is protected.