Trusts and Inheritance Tax: The Pros and Cons Families Need to Know

Trusts come up in almost every serious conversation about inheritance tax planning. They are powerful, flexible, and when used correctly, can be one of the most effective ways to protect family wealth across generations. But they are also widely misunderstood, frequently oversold, and can create significant problems when established without specialist advice.

This guide covers what trusts actually are, how they interact with UK inheritance tax, and the honest advantages and disadvantages every family should consider before setting one up.

What Is a Trust?

A trust is a legal arrangement in which one person — the settlor — transfers assets to another person or group of people — the trustees — to hold and manage for the benefit of named or defined beneficiaries.

Once assets are placed in a trust, they no longer belong to the settlor. The trustees become the legal owners, with a duty to manage the assets in accordance with the terms of the trust deed and in the interests of the beneficiaries.

Trusts can hold almost any type of asset — property, cash, investments, life insurance policies, or business interests.

How Do Trusts Reduce Inheritance Tax?

The core principle is straightforward. Assets held in trust no longer form part of the settlor's estate, so they are not subject to inheritance tax when the settlor dies — provided the transfer was made correctly and the settlor survives seven years from the date of the transfer.

This makes a trust a potentially powerful tool for removing assets from an estate while retaining some degree of control over how those assets are eventually distributed — something a straightforward gift does not allow.

The most common and accessible example is a life insurance policy written in trust. A policy written in trust pays out directly to beneficiaries without forming part of the estate, meaning the proceeds are available immediately — without waiting for probate — and with no IHT liability on the payout. This is a relatively simple step that almost any family can take, often at no additional cost to the policy premium.

The Pros of Using a Trust for Inheritance Tax Planning

1. Assets Can Be Removed from Your Taxable Estate

Assets placed in trust — done correctly and with the seven-year rule satisfied — can be removed from your taxable estate entirely. For larger estates where the IHT bill would otherwise be significant, this can represent a very substantial saving. The 40% IHT rate on assets above the nil rate band means that for every £1 million removed from the estate via a trust, the potential saving is up to £400,000.

2. You Can Set Conditions on How and When Beneficiaries Receive Assets

A trust allows the settlor to specify that funds are released at a certain age, for specific purposes such as education or a first property purchase, or only in defined circumstances. This level of control is simply not available with an outright gift. For families with young children, financially inexperienced beneficiaries, or beneficiaries who may face creditor claims, this flexibility is invaluable.

3. Asset Protection for Beneficiaries

Trusts can protect assets from beneficiaries' creditors, divorce proceedings, or financial mismanagement. If a beneficiary goes through a difficult divorce, faces bankruptcy, or simply lacks the financial maturity to manage a large inheritance, assets held in trust are far better protected than assets transferred by gift or inherited outright.

4. Discretionary Trusts Adapt to Changing Circumstances

A discretionary trust gives trustees the flexibility to respond to changing family circumstances — distributing income or capital to different beneficiaries depending on their needs at any given time. This is particularly valuable for families where individual beneficiaries' situations may change significantly over a long period.

5. Assets Pass Without Probate

Assets held in trust pass to beneficiaries outside the probate process, which means faster distribution, lower costs, and no public record of what was held in the trust or who received it. In cases where probate is delayed — which can take many months — this can make a real practical difference to beneficiaries' access to funds.

The Cons of Using a Trust for Inheritance Tax Planning

1. Trusts Are Not Simple or Cheap

Setting up a trust correctly requires a solicitor experienced in trust and estate planning — not a generic will writer or online template. Ongoing administration adds further cost and complexity: annual accounts, trust tax returns, and formal trustee decisions. Many families underestimate the long-term administrative burden, and the cost of getting this wrong is often higher than the cost of getting proper advice at the outset.

2. Trusts Have Their Own Inheritance Tax Regime

This is the part many people do not realise until after a trust is established. Relevant property trusts — the most common type used for IHT planning — face a periodic charge of up to 6% on the value of assets held in the trust every ten years, and an exit charge when assets are distributed to beneficiaries. These charges can erode the tax benefit significantly if the trust is not properly managed. A trust that removes assets from an estate but faces recurring 10-year charges is not automatically more tax-efficient than alternatives.

3. The April 2026 BPR/APR Cap Applies to Trusts Too

Following the April 2026 IHT reforms, the £2.5 million cap on Business Property Relief and Agricultural Property Relief applies to trusts as well as individuals. New anti-fragmentation rules specifically block the strategy of splitting qualifying assets across multiple trusts to multiply the relief. Planning that worked before April 2026 may no longer be effective, and existing trust structures holding BPR or APR assets need to be reviewed urgently.

4. Placing Assets in Trust Is Generally Irreversible

Once assets are transferred into a trust, the settlor no longer owns them and cannot simply take them back. This is a significant consideration for anyone who may need access to those assets in the future — for long-term care costs, for example, or in the event of unexpected financial difficulty. The irrevocable nature of most trust structures means the decision needs to be made with a long-term view.

5. The Gift with Reservation of Benefit Trap

If you place your home in a trust but continue to live in it without paying a full market rent, HMRC will treat it as a gift with reservation of benefit — meaning it still forms part of your estate for IHT purposes, defeating the purpose of the arrangement entirely. This is one of the most common and costly mistakes in DIY estate planning, and it can take years before the error is discovered — often not until the estate is being administered after death.

6. Capital Gains Tax and Income Tax Implications

Trusts can have capital gains tax and income tax implications that vary significantly depending on the type of trust, the assets held, and the circumstances of the beneficiaries. A trust that reduces an inheritance tax liability can sometimes generate a CGT liability that partially offsets the saving. Understanding the full tax picture across all taxes — not just IHT — is essential before proceeding.

The Three Main Trust Types Used for IHT Planning

Discretionary Trusts

The most common type used in inheritance tax planning. Trustees have full flexibility over how and when assets are distributed to beneficiaries — making this the most versatile option. The trade-off is that discretionary trusts fall within the relevant property regime, meaning periodic charges of up to 6% every ten years and exit charges on distributions apply. Best suited to larger estates with complex circumstances, or where the settlor wants maximum ongoing flexibility.

Bare Trusts

Simpler and cheaper to administer than discretionary trusts, with no ongoing IHT periodic charges. However, the beneficiary has an absolute right to the assets at age 18 — meaning there is no ability to restrict or delay access beyond that point. Useful for gifts to children or grandchildren where the settlor is comfortable with the beneficiary receiving the assets outright at adulthood.

Interest in Possession Trusts

Gives a named beneficiary the right to income from the trust during their lifetime, with the underlying capital passing to others on their death. Commonly used in second marriage situations — for example, to provide for a second spouse while ensuring the capital ultimately passes to children from a first marriage. The IHT treatment depends on when the trust was created and its specific structure.

Are Trusts Worth It for Your Situation?

For the right family in the right circumstances, absolutely. A life insurance policy written in trust costs relatively little to set up, removes the policy proceeds from the estate entirely, and gives beneficiaries access to funds immediately without waiting for probate. For most families with life insurance, this is a straightforward improvement with very few downsides.

For larger estates with complex assets — business interests, significant investment portfolios, or agricultural land — trust planning can form an essential part of a broader IHT strategy. But it needs to sit alongside professional advice on the interaction with Business Property Relief, capital gains tax, and the post-2026 rules.

Where trusts tend to go wrong is when they are set up without specialist legal advice, when the settlor underestimates the ongoing administrative burden, or when the arrangement is structured in a way that HMRC subsequently challenges — most commonly through the gift with reservation rules.

Frequently Asked Questions: Trusts and Inheritance Tax