The role of trusts in inheritance tax planning

Few taxes spark as much debate as inheritance tax (IHT). Many see it as an unfair ‘double tax’ on assets already taxed during a person’s lifetime. Others are often surprised to find themselves caught by it at all. A survey earlier this year suggested seven in ten UK adults don’t understand how IHT works[1], so it’s no surprise some families are left shocked by the bill.

The threshold at which IHT becomes payable has been frozen at £325,000 since 2009. This means the first £325,000 of an estate is tax free, but everything above that amount is taxed at 40%. There is an additional allowance – the residence nil-rate band – which can apply when passing on a family home to direct descendants, but even with this, rising property and investment values have pulled more estates into triggering an IHT bill. However, trusts can help reduce IHT, while giving families control over how assets are passed on.

Trusts and IHT

A trust is a legal arrangement that lets the settlor transfer assets to trustees who hold them on behalf of chosen beneficiaries. Trusts can be created during your lifetime or be specified in a will. They are widely used in estate planning to protect assets, provide for family members, and manage IHT exposure. The main types of trust used in estate planning include:

Discretionary trusts: Trustees decide how, when and to whom assets are distributed. Useful for flexibility but subject to specific inheritance tax charges, including potential lifetime, ten-year and exit charges.
Bare trusts: Beneficiaries have an absolute right to the assets. For IHT, these are treated as potentially exempt transfers and fall outside the estate provided the settlor survives seven years.
Interest in possession (life interest) trusts: A named beneficiary has the right to income during their lifetime, while capital passes to others later. The IHT treatment depends on whether the trust is created during life or by will.

Each structure has different implications in terms of control over the assets, flexibility, and tax. Choosing the right type of trust depends on the size of the estate, the family’s circumstances, and the balance between tax efficiency and fairness.

Fairness considerations

Trusts can help families share assets between children, stepchildren and future generations in a structured way. Used carefully, they balance efficiency with fairness, ensuring beneficiaries are treated equitably.

Efficiency considerations

Trusts can make estate planning more efficient by reducing the size of a taxable estate, spreading liabilities across generations, and making use of exemptions such as the nil-rate band. They also give families flexibility to plan around future changes in tax law or family circumstances. However, efficiency is not the same as simplicity. Trusts bring with them administrative costs, HMRC reporting requirements, and the need for accurate record-keeping. Poorly managed trusts can create more problems than they solve.

Key considerations for individuals

Anyone thinking of using a trust for IHT planning should keep in mind that:

Professional advice can ensure the structure is legally sound and compliant with HMRC rules.
Trusts should be tailored to the size of the estate and the family’s circumstances. Smaller estates may not benefit from complexity.
Trusts should be reviewed regularly as laws and family dynamics change.
Transparency and communication with beneficiaries can avoid disputes later on.

Trust arrangements with Attwaters

At Attwaters, we design trusts that protect assets, reduce unnecessary tax, and reflect family priorities. Our Wills, Trusts & Probate team has been advising clients for over a century, combining technical expertise with a practical understanding of family needs. To discuss how trusts could support your long-term planning, contact lubna.zaman@attwaters.co.uk or henrietta.oforma@attwaters.co.uk or call 0330 221 8855.

[1] https://www.unbiased.co.uk/news/personal-finance/71-of-uk-adults-don-t-understand-iht-schroders-report-reveals