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. 

Table of Contents

• What Is a Trust? 

• How Trusts Minimise Estate Taxes in the UK 

• Types of Trusts in the UK 

  • Bare Trusts (Simple Trusts) 

  • Discretionary Trusts 

  • Interest in Possession Trusts 

  • Trusts for Business Assets 

  • Charitable Trusts

• Benefits of Using Trusts for Asset Protection in the UK 

• Key Considerations When Setting Up a Trust in the UK 

• Conclusion 

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 are no longer considered part of the settlor’s estate for IHT purposes. As a result, they are not subject to IHT upon the settlor’s death. 

• Lifetime Gifts and Exemptions: When gifting assets to a trust, the settlor may be eligible for annual gift exemptions (£3,000 per year) and potentially exempt transfers (PETs). Gifts made to a trust will generally be exempt from IHT if the settlor survives for seven years after the transfer. 

• Tax-Free Transfers of Business Assets: Business Relief (BR) allows business assets to be transferred free from IHT under certain conditions. 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 without incurring a heavy tax burden. 

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:

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.
  

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 a trusted 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. 

Meet Omar Omar is a Chartered Tax Advisor (a.k.a an expert on tax issues) and founder of ASWATAX. He regularly shares his knowledge and best advice here in his blog and on other channels such as LinkedIn. Book a call today to learn more about what Omar and ASWATAX can do for you.

*Disclaimer: ASWATAX is a firm of Chartered Tax Advisors, and we strive to provide accurate, up-to-date tax insights. Tax laws may change, so this content is for general guidance only and not a substitute for professional advice. Seek independent tax and legal counsel before making decisions. ASWATAX is not liable for any loss from reliance on this information. Use at your own risk.