As an alternative to outright gifts, trusts can allow assets to be passed down the generations in a more controlled way.

A trust exists where there is a separation of legal and beneficial ownership. The act of placing assets such as money, shares, land or buildings into trust is known as making a settlement, and the assets transferred are known as settled property. A settlor is the person who establishes a trust and settles or transfers the trust property to the trustees, for the benefit of the beneficiaries.

A trust exists where there is a separation of legal and beneficial ownership.

While a trust can provide greater control over where assets eventually go, there can also be drawbacks, particularly the inheritance tax implications associated with different types of trusts.

The two most common trusts

Trust structures

01

Discretionary trust

Trustees decide whether, when and to whom income or capital is distributed.

02

Interest in possession trust

The life tenant has an immediate right to income or enjoyment of the assets; the remainderman ultimately receives the capital.

Discretionary trust

A discretionary trust gives the trustees discretion over whether, when and to whom income or capital is distributed. Because no beneficiary has an automatic entitlement to the trust assets, the assets held in the trust do not generally form part of any beneficiary’s estate for inheritance tax purposes while they remain in trust.

That doesn’t mean a discretionary trust falls outside inheritance tax altogether . Instead, it’s usually subject to the ‘relevant property’ regime, under which inheritance tax charges can arise when assets are transferred into the trust, on each ten-year anniversary of the trust’s creation, and when assets leave the trust.

Trust charges can arise at three points. The first of these, the entry charge, applies when the settlor funds the trust during their lifetime. The transfer is generally treated as a chargeable lifetime transfer and is taxed at 20% on any value exceeding the settlor’s available nil-rate band. If the settlor dies within seven years of making the transfer, a further charge can apply, up to 40% on the value above the nil-rate band, with credit given for the 20% already paid. Taper relief may reduce this additional charge if death occurs more than three years after the transfer was made.

The other two charges apply to the trust itself. On each ten-year anniversary, a periodic charge of up to 6% may apply to the value of the trust above the nil-rate band. An exit charge may also arise when assets are distributed from the trust, calculated in proportion to how long they’ve been held since the trust started or since the last periodic charge.

Discretionary trust charges

01

Entry

potentially 20% above available NRB

02

Periodic

up to 6% at ten-year anniversaries

03

Exit

may arise when assets leave the trust

Worked example: funding a discretionary trust

Priya transfers £500,000 into a discretionary trust for her grandchildren. Her available nil-rate band is £325,000, so £175,000 of the transfer is chargeable.

DetailAmount
Transfer into trust£500,000
Available nil-rate band£325,000
Chargeable amount£175,000
Entry charge, at 20%£35,000

If Priya survives seven years from the date of the transfer, no further inheritance tax will arise in respect of that transfer. If Priya dies within seven years of making the transfer, the transfer is recalculated using the death rate of inheritance tax (40%). Credit is given for the £35,000 lifetime tax already paid, and taper relief may reduce the additional tax if death occurs more than three years after the transfer.

Interest in possession trust

An interest in possession trust works differently. One beneficiary, known as the life tenant, has an immediate right to the income from, or enjoyment of, the trust assets. Another beneficiary, the remainderman, becomes entitled to the trust’s capital once the life tenant’s interest ends.

The inheritance tax treatment depends largely on when the trust was created. For many interest in possession trusts established before 22 March 2006, the life tenant was treated for inheritance tax purposes as owning the underlying trust assets. As a result, transfers into such trusts were often treated similarly to outright gifts rather than falling within the relevant property regime.

Since 22 March 2006, most newly created lifetime interest in possession trusts have fallen within the relevant property regime, meaning they can be subject to inheritance tax, entry, ten-year and exit charges, broadly in the same way as discretionary trusts. However, a number of important exceptions exist, including certain trusts created on death and trusts for disabled beneficiaries.

 

Where Business Relief (BR) can help

This is where a BR-qualifying investment can help. If trust assets are invested in a qualifying Business Relief investment, such as the Ingenious Estate Planning service, and that investment is held for at least two years while continuing to meet the relevant qualifying conditions, its value may be excluded from the relevant property calculation for inheritance tax purposes, potentially reducing or eliminating periodic and exit charges.

Case study: an interest in possession trust for a surviving spouse

Margaret and David are married. David’s will leaves his estate into a trust for Margaret’s lifetime benefit, with their children named as remaindermen. This is known as an immediate post-death interest, since it’s created on David’s death and gives Margaret an immediate right to the trust’s income.

For inheritance tax purposes, Margaret is treated as beneficially entitled to the trust property. As a result, the transfer into the trust on David’s death qualifies for the spouse exemption, so no inheritance tax charge arises when the trust is created.

Although Margaret cannot access or give away the trust capital, it still forms part of Margaret’s own estate for inheritance tax purposes. If the trustees invest the trust’s assets in a Business Relief qualifying investment, and it’s held for at least two years and continues to meet the qualifying conditions, its value may pass to the children, as remaindermen, without an inheritance tax charge arising on Margaret’s death.

Trust reforms from Budget 2024

Similar to the changes affecting Business Relief and Agricultural Property Relief, the Autumn Budget 2024 introduced a £2.5 million allowance for relevant property trusts.

A trust does not automatically qualify for this allowance in all circumstances. Instead, a trust acquires this allowance only if qualifying property is settled into it on or after 30 October 2024. The amount of the allowance is based on the value of the Business Relief or Agricultural Property Relief claimed by the settlor when the qualifying property is settled into trust. It is capped at £2.5 million across all trusts settled by the same settlor.

Trusts do not automatically qualify for their own £2.5 million 100% relief allowance.

This 100% allowance applies to exit charges and periodic charges, refreshing after the first quarter following each ten-year anniversary. Broadly, trusts settled before 30 October 2024 may benefit from transitional provisions that allow them to access a separate £2.5 million allowance, although the detailed position depends on the trust’s circumstances.

Any comparison between BR-qualifying investments and other estate planning options should be made with a regulated adviser and a full assessment of a client’s circumstances. BR investments are high risk and may involve unquoted investments. Eligibility for B is not guaranteed. Tax treatment depends on individual circumstances and may change in the future.

Common questions

Does inheritance tax apply when a trust is set up?

It can. Funding a discretionary trust, or an interest in possession trust created on or after 22 March 2006, is generally treated as a chargeable lifetime transfer, taxed at 20% on the value above the settlor’s available nil-rate band. A trust created for a surviving spouse on the first spouse’s death, an immediate post-death interest, is typically exempt instead, since transfers between spouses are exempt from inheritance tax.

Can a Business Relief qualifying investment reduce inheritance tax within a trust?

It may. If a trust’s assets are invested in property that qualifies for BR, and that investment has been held for at least two years while continuing to satisfy the relevant qualifying conditions, its value may be relieved from inheritance tax, potentially reducing or eliminating periodic and exit charges. BR is not guaranteed, and this depends on the investment continuing to meet the qualifying conditions.

Do all trusts have their own £2.5 million Business Relief allowance?

No. Only qualifying property placed into a trust on or after 30 October 2024 counts towards the new 100% BR/Agricultural Property Relief (APR) allowance. From 6 April 2026, trusts created by the same settlor after that date must share a £2.5 million allowance. Trusts set up before 30 October 2024 are generally treated separately, so each can have its own £2.5 million allowance.

How does a discretionary trust work?

A discretionary trust gives the trustees discretion over whether, when and to whom income or capital is distributed. No beneficiary has an automatic entitlement to the trust assets while they remain in trust.

For inheritance tax purposes, a discretionary trust is usually subject to the relevant property regime, which means charges can arise when assets are transferred into the trust, on each ten-year anniversary and when assets leave the trust.

Ingenious Insights: more from the adviser education series

01

What is inheritance tax and who pays it?

A plain-English guide for advisers: how inheritance tax works, the key allowances and why more estates are affected than ever before.
Read more
02

What is Business Relief?

How Business Relief works, what qualifies, and what's changing from April 2026, including the new £2.5m allowance and the AIM shares change.
Read more
03

Inheritance tax changes 2026

A practical summary of the April 2026 inheritance tax changes and the steps advisers should take to protect their clients' estate plans now.
Read more
04

What does an investment in IEP provide?

An adviser's guide to what an IEP investment provides: Business Relief, optional insurance cover, a defined strategy, access to capital and Investors' Relief.
Read more
05

How does a Business Relief investment compare to other estate planning options?

Business Relief investments, gifts, trusts, AIM shares and life insurance for inheritance tax compared: the advantages and risks of each estate planning solution.
Read more
06

Business Relief and Trusts

Entry, periodic and exit charges explained for discretionary and interest in possession trusts, with worked examples and how Business Relief can help.

TECHNICAL TEAM

Simon Palmer

Simon Palmer

Group Technical Director

Sebastien Couplez

Sebastien Couplez

Technical Director

Jack Ingilby

Jack Ingilby

Technical Manager

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