How to Mitigate Inheritance Tax with a Trust (UK Guide)

This article is for general information only and does not constitute financial advice. The value of investments and assets can go down as well as up, and tax treatment depends on individual circumstances and may change in the future. If you are considering inheritance tax planning, including the use of trusts, it is important to speak to a qualified financial adviser to ensure any decisions are suitable for your situation.

Inheritance tax (IHT) can significantly reduce the value of your estate passed on to loved ones. With the current threshold and tax rate, many families are now affected, not just the very wealthy.

One of the most commonly discussed strategies is the use of trusts. When used correctly, trusts can play an important role in estate planning, helping to manage how and when your assets are passed on while potentially reducing inheritance tax exposure.

This guide explains how trusts work in the UK, how they can help with inheritance tax planning, and what to consider before putting one in place.

What Is Inheritance Tax in the UK?

This guide is intended for UK residents with estates that may be subject to inheritance tax

Inheritance tax is charged on the value of your estate when you pass away. This includes property, savings, investments, and certain gifts made during your lifetime.

As outlined in guidance from GOV.UK:

The standard nil-rate band is £325,000
Anything above this threshold may be taxed at 40%
Additional allowances may apply, such as the residence nil-rate band when passing a home to direct descendants

While there are exemptions and reliefs available, many estates still face a significant tax bill without proper planning.

What Is a Trust?

A trust is a legal arrangement where assets are placed under the control of trustees for the benefit of one or more beneficiaries.

There are three key roles:

Settlor - the person who creates the trust and places assets into it
Trustees - the individuals responsible for managing the trust
Beneficiaries - the people who benefit from the trust

Trusts can be used for a range of purposes, including protecting assets, controlling how wealth is distributed, and planning for inheritance tax.

How Trusts Can Help Reduce Inheritance Tax

When considering how to avoid inheritance tax with a trust in the UK, the key principle is this:

In some cases, and subject to specific rules (including gift with reservation and trust tax regimes), assets may fall outside your estate.

By placing assets into certain types of trusts, you may be able to reduce the taxable value of your estate, depending on how the trust is structured and how long the assets remain outside your ownership.

However, this is not a simple “one size fits all” solution. The tax treatment of trusts depends on the type of trust used and your individual circumstances.

Types of Trusts Used in Inheritance Tax Planning

Bare Tusts

With a bare trust, the beneficiary has an immediate and absolute right to the assets.

Often used for children
Assets are typically treated as belonging to the beneficiary
Limited inheritance tax advantages for the settlor

Discretionary Trusts

Discretionary trusts give trustees flexibility over how and when assets are distributed.

Useful for families wanting control over distribution
Can help with long-term estate planning
May be subject to periodic and exit charges

Interest in Possession Trusts

These trusts allow a beneficiary to receive income from the trust during their lifetime, with capital passing to others later.

Often used in family or spousal planning
Can provide income security while preserving capital

Loan Trusts and Gift Trusts

These are commonly used in financial planning strategies.

Allow individuals to retain some access or control
Can help reduce estate value over time

Often used alongside investment strategies

The 7-Year Rule Explained

A key factor when using trusts for inheritance tax planning is the 7-year rule.

If you place assets into a trust and survive for seven years after making the transfer, those assets are typically considered outside your estate for inheritance tax purposes.

However:

If you pass away within seven years, the transfer may still be taxed
Taper relief may reduce the tax payable over time
Some trusts may still face immediate or ongoing tax charges

Things to Consider Before Setting Up a Trust

While trusts can be effective, they are not suitable for everyone. It’s important to consider:

Loss of Control

Once assets are placed into a trust, you no longer legally own them. Trustees are responsible for managing them.

Tax Implications

Trusts can have their own tax rules, including:

Inheritance tax charges on entry (in some cases)
Ongoing charges every 10 years
Potential income tax and capital gains tax

In addition, specific anti-avoidance rules may apply:

Gift With Reservation of Benefit (GWR) - if you continue to benefit from an asset after placing it into a trust, it may still be treated as part of your estate for inheritance tax purposes
Pre-Owned Asset Tax (POAT) - In some cases, if assets are given away but you continue to benefit from them, an income tax charge may apply

These rules are designed to prevent individuals from reducing inheritance tax while still retaining access to the assets.

Costs and Administration

Trusts require ongoing management, including record keeping, tax reporting, and trustee responsibilities.

Changing Legislation

Tax rules around trusts can change. What works today may not be as effective in the future, which is why regular reviews are important.

Are Trusts the Only Way to Reduce Inheritance Tax?

No. Trusts are just one part of a wider inheritance tax planning strategy.

Other approaches may include:

Making use of annual gifting allowances
Passing assets between spouses or civil partners
Using pensions as part of estate planning
Structuring investments tax-efficiently

A well-rounded plan often combines several strategies rather than relying on a single solution.

Why Professional Advice Matters

Inheritance tax planning is a complex area, particularly when trusts are involved.

The rules surrounding ownership, taxation, and timing are detailed, and mistakes can lead to unintended tax consequences or loss of flexibility.

Working with a qualified financial adviser ensures that:

Any trust is appropriate for your situation
The structure aligns with your long-term goals
You remain compliant with UK tax regulations
Your plan can adapt as your circumstances change

Final Thoughts

Understanding how to avoid inheritance tax with a trust in the UK starts with recognising that trusts are a planning tool, not a shortcut.

Used correctly, they can help you:

Reduce the value of your taxable estate
Maintain control over how assets are passed on
Provide long-term financial security for your family

However, they need to be carefully structured and regularly reviewed to remain effective.

Speak to a Qualified Financial Advisor

If you are considering using a trust as part of your inheritance tax planning, it’s important to get clear, personalised advice.

At McCarthy Wealth Management, we take a straightforward and considered approach to financial planning, helping you understand your options and build a strategy that works for your circumstances.

Contact McCarthy Wealth Management today to arrange a conversation and start planning your financial future with confidence.

This article is for informational purposes only and does not constitute financial advice. Individual circumstances and tax treatment may vary and should be reviewed with a qualified professional.

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