Gift Trusts - How Do They Work?
This article provides general information only and does not constitute personal financial, investment, tax or legal advice or a personal recommendation. A gift into trust may be difficult or impossible to reverse, depending on the trust terms and legal structure. Tax treatment depends on the trust structure, the assets involved and individual circumstances, and tax rules may change.
A gift trust is a type of trust arrangement that can be used to hold assets for the benefit of others, subject to the terms of the trust. In the straightforward type of gift trust discussed here, the person making the gift, known as the settlor, normally gives up beneficial access to the assets transferred, subject to the specific trust terms.
For tax purposes, the label “gift trust” does not by itself determine how the arrangement is treated. The underlying trust structure, who can benefit and the rights created by the trust all affect how it works.
What actually changes when assets go into a gift trust?
A trust separates legal ownership from beneficial entitlement. Trustees hold and administer the assets, while the beneficiaries are the people entitled, or potentially entitled, to benefit.
Three roles are central:
- Settlor: the person who creates the trust and makes the gift
- Trustees: the people responsible for administering the assets under the trust terms
- Beneficiaries: the people who are entitled, or may become entitled, to benefit
Once assets are genuinely transferred, the settlor's relationship with them changes. The money or investments should not be treated as though they remain in an account that can be accessed whenever needed.
HMRC's guide to the different types of trust explains that beneficiary rights and trustee powers differ according to the underlying structure.
Our guide to using trusts to mitigate Inheritance Tax looks more broadly at how trusts can feature within estate planning.
How a gift trust is set up and administered
The exact process depends on the trust deed and the assets involved, but a gift trust commonly involves the following stages.
- The purpose and intended beneficiaries are identified. This establishes who the arrangement is intended to benefit.
- The trust terms are created. The deed sets out the trustees, beneficiaries and the powers available to the trustees.
- Assets are transferred. The settlor makes the gift into the trust.
- The trustees administer the assets. They must act in accordance with the trust terms and their legal responsibilities.
- Benefits are provided under the trust. How and when this happens depends on the rights created by the particular structure.
This is why the underlying trust matters more than the label “gift trust”. Two arrangements carrying that description can create different beneficiary rights and tax consequences.
Bare and discretionary gift trusts are not the same
Two common structures used for lifetime gifting are bare trusts and discretionary trusts.
| Question | Bare trust | Discretionary trust |
|---|---|---|
| Who benefits? | Beneficiary or beneficiaries are fixed | Trustees usually choose from a defined class |
| Beneficiary rights | Beneficiary is absolutely entitled to the trust property | No individual beneficiary is automatically entitled to a particular share |
| Flexibility | Limited | Greater trustee discretion |
| Typical IHT treatment of the initial lifetime gift | A qualifying gift is generally a potentially exempt transfer where the beneficiary is absolutely entitled | A lifetime transfer into most relevant-property discretionary trusts is generally an immediately chargeable transfer for IHT purposes |
| Relevant property charges | Generally outside the relevant property regime | Ten-year and exit charges can apply |
In a bare trust, the beneficiary has an absolute beneficial entitlement. That provides certainty over who will ultimately receive the trust property but leaves little room to change beneficiaries later.
A discretionary trust gives trustees greater flexibility over who benefits, when and by how much, within the powers granted by the trust. The trade-off is a different and potentially more complex tax and administrative position.
An immediately chargeable transfer does not necessarily mean that Inheritance Tax is payable when the gift is made. The liability depends on factors including the value transferred, previous chargeable transfers and any available nil-rate band, exemptions or reliefs.
The appropriate structure therefore depends on the intended beneficiary rights and degree of flexibility required, rather than simply on which option appears more favourable for tax.
What does a gift trust mean for Inheritance Tax?
Putting assets into trust does not automatically remove them from an estate for Inheritance Tax purposes.
A qualifying lifetime gift into a bare trust will generally be treated as a potentially exempt transfer where the beneficiary is absolutely entitled. If the settlor survives for seven years, the transfer may fall outside their estate for IHT purposes, subject to the applicable rules and circumstances.
A lifetime transfer into most relevant-property discretionary trusts is generally an immediately chargeable transfer for Inheritance Tax purposes. Whether tax is actually payable when the transfer is made depends on factors including the value transferred, earlier chargeable transfers and any available nil-rate band, exemptions or reliefs.
Relevant property trusts can also be subject to tenth anniversary and exit charges. HMRC's guidance on trusts and Inheritance Tax explains how the treatment differs between trust structures.
The settlor's continuing relationship with the gifted property also matters. If the settlor is not excluded, or virtually excluded, from benefiting from gifted property, the gift with reservation rules may apply. In practical terms, this means the property can remain relevant when the estate is assessed for Inheritance Tax even though it has been transferred.
Tax outcomes are not guaranteed. Whether gifted assets fall outside an estate depends on the structure, timing and individual circumstances, not simply on placing them in trust.
Giving up access deserves as much attention as the tax position
For many people, loss of access is the more immediate financial issue.
Where assets have genuinely been gifted, and the settlor is excluded from benefiting, they should not be treated as an emergency reserve or capital that can simply be reclaimed later.
Before making a substantial gift, relevant considerations include:
- how much capital may be needed for retirement and later life
- whether future expenditure could change how much is affordable to give
- whether you could continue to meet your foreseeable future expenditure without relying on the assets being transferred
- whether the intended beneficiaries need certainty or flexibility
- whether the trustees are prepared to take on their responsibilities
- whether an outright gift could achieve the same objective more simply
Our guide to gifts and Inheritance Tax planning covers lifetime gifting more broadly, including exemptions and the importance of considering affordability before giving assets away.
A gift trust can create other tax and reporting responsibilities
Inheritance Tax is only one part of the position.
Transferring assets that have risen in value can have Capital Gains Tax consequences. HMRC's guidance on trusts and Capital Gains Tax explains how CGT can arise in connection with assets transferred to or from a trust.
Income arising within a trust can also be taxed differently depending on the structure and who is entitled to it.
Trustees should also establish whether the arrangement needs to be registered with HMRC. HMRC's Trust Registration Service guidance explains which trusts must be registered and the circumstances in which exclusions can apply.
These responsibilities should be considered from the outset rather than viewing a trust only in terms of its potential Inheritance Tax treatment.
How does a gift trust differ from other ways of transferring wealth?
A straightforward gift trust is built around a genuine gift for beneficiaries. That distinguishes it from arrangements in which the person providing the capital deliberately retains different rights.
| Arrangement | Main distinction |
|---|---|
| Gift trust | Assets are gifted but held within a trust structure for beneficiaries |
| Outright gift | Assets pass directly to the recipient |
| Loan trust | Capital is advanced as a loan, so an outstanding amount may remain repayable |
| Discounted gift trust | A gift is made while defined payment rights are retained from the outset |
These approaches are not interchangeable. Access to capital, beneficiary rights, administration and tax treatment can differ materially.
If access to the original capital may still be required, a straightforward gift trust may not fit the objective.
When can a gift trust be relevant?
A gift trust can be relevant where someone is able to make a genuine lifetime gift but wants the assets held within a defined structure rather than transferred directly to a beneficiary.
Before choosing a trust, it is important to establish what the arrangement needs to achieve. Relevant questions include who should benefit, whether those beneficiaries should be fixed, how much trustee discretion is appropriate and whether the settlor can afford to give up access to the assets.
The additional administration and potential tax complexity should also be proportionate to the purpose of the arrangement. In some circumstances, an outright gift may achieve the intended result more simply.
If you are considering gifting or using a trust as part of your wider financial planning, our Estate and Lifestyle Planning service can provide information about our approach to estate planning, gifting strategies, Inheritance Tax analysis and wealth transfers. The appropriate approach depends on your individual circumstances and may require financial, tax or legal advice.
Legal advice may be needed on the creation and terms of a trust. Where an arrangement involves regulated investments, regulated financial advice may also be appropriate.
McCarthy Wealth is a trading style of Clarity Wealth Management LLP which is authorised and regulated by the Financial Conduct Authority. No: 575252
The Financial Conduct Authority does not regulate advice on estate planning, wills or probate. Tax and trust planning may also fall outside FCA regulation. Where an arrangement involves regulated investments, the associated investment advice may be regulated. This article is for general information only and does not constitute a personal recommendation. Tax treatment depends on individual circumstances and may change.
