Government plans to make inheritance tax due on pensions, plus other changes to IHT rules, have seen a leap in people enquiring about the use of trusts to protect their wealth. So what are trusts, and how can they help you avoid paying more tax than you need?
With inheritance tax (IHT) set to apply to pensions from April 2027, and the scrapping of 100% business property relief and agricultural property relief from April 2026, legacy wealth planning is becoming increasingly tricky.
Many people are now reconsidering how their wealth is structured for future generations, and trusts – a way of ringfencing assets – are playing a larger role when it comes to financial plans.
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Wealth manager Quilter, for example, saw an almost 200% increase in the number of trusts opened in 2024 compared to 2023, and uptake in 2025 is already on track to far surpass this level, it said recently, as more people seek to avoid inheritance tax.
We explain what trusts are and how you can use them in your financial planning and to reduce your inheritance tax bill.
What is a trust?
A trust is “a legal arrangement where assets – money, property, investments – are passed to trustees, who look after them on behalf of beneficiaries,” explained Jude Dawute, managing director of financial advice firm Benjamin House.
“It’s a useful way to control when and how wealth is passed on, to protect assets, and to reduce inheritance tax,” he added.
Trusts separate an asset’s legal ownership from the beneficial ownership. What this means in practice is that there are always at least three people involved in a trust; the settlor, trustee and beneficiary.
A person known as the ‘settlor’ places assets into a trust. This may be done during their lifetime (a lifetime trust) or can be triggered by death through a valid will (a will trust).
By placing the assets into this structure, the original owner may relinquish some of their rights and give responsibility to a trustee during their lifetime. However, they can gain a lot more control in other ways.
A settlor can project their wishes years into the future. Provided a trust is set up correctly, you can determine who gets what and when with a good deal of precision. Trustees can be professionals (who work for a trust company) or any other competent person prepared to take on these responsibilities.
The trustee is the legal owner of the trust, who has the power to deal with and administer trust’s assets.
Then there is the beneficial owner – the person who actually benefits from the trust, in terms of the use, income or proceeds from the sale of any assets in the trust.
Why would you use a trust?
Trusts can be useful for a number of reasons, mainly:
- to keep assets outside of your estate to avoid inheritance tax;
- to control who receives money and when, especially if children or vulnerable beneficiaries are involved;
- to avoid probate delays, particularly with life insurance payouts;
- to protect wealth across generations.
Liam Chapman-Lyes, senior paraplanner at Succession Wealth, said "trusts are a powerful tool for estate planning, providing flexibility and control over asset distribution.
“Properly structured, they can address various scenarios and requirements, ensuring that your legacy is managed according to your wishes long into the future.”
There are a number of different types of trust. The most common are:
- discretionary trusts: the most flexible, allowing trustees to decide when and how to distribute money;
- spousal bypass trusts: these protect lump sums like death-in-service payouts from inflating a surviving spouse’s estate;
- bare trusts: the simplest form of trust, where assets are held in the name of the trustee but they have no discretion over the assets held in trust.
Using a trust to avoid inheritance tax
Inheritance tax is the gift that keeps on giving for the Treasury, with inheritance tax receipts continuing to rise.
The current inheritance tax rate is 40%. This is payable on anything over the £325,000 threshold (known as the nil-rate band). However if you own a home you also get a residence nil-rate band. This is currently £175,000.
So you potentially have a personal threshold of £500,000 before inheritance tax is levied against your estate. Couples who are married or in a civil partnership can pass up to £1 million onto direct descendants.
Using trusts can help you reduce your tax liabilities for the portion of your estate that exceeds this threshold.
Stacey Love, technical manager, tax, trusts and estate planning at Canada Life, said: “While the trend is only on the way up, IHT continues to be largely a discretionary tax. Many estates may not have to pay IHT at all if the various exemptions are used appropriately.”
There are a few ways trusts can be set up to benefit your loved ones while avoiding inheritance tax. You’ll usually want to speak to an expert to help with this though, like a financial adviser or accountant.
Dawute gave three everyday examples of how he uses trusts to help clients reduce inheritance tax bills.
1. Life insurance in a discretionary trust
“Most clients don’t realise that if life insurance isn’t written into trust, it forms part of the estate, potentially triggering 40% inheritance tax and delays through probate”, Dawute said.
By writing it into a discretionary trust, the funds are paid quickly, tax-free, and outside of the estate, avoiding IHT.
However transfers into a discretionary trust can come with an entry charge if the transfer is higher than your available inheritance tax nil rate band – an immediate charge of 20% on the amount over.
2. Trusts with onshore and offshore bonds
Dawute sometimes advises clients who sell businesses or receive large lump sums to use investment bonds to grow their wealth tax-efficiently. Placing those bonds into a trust can protect them from inheritance tax.
“It can allow the family to benefit over time, often assigning segments to children at lower tax rates, or protecting the capital from future IHT charges altogether,” he said.
3. Spousal bypass trusts for death-in-service benefits
While death-in-service benefits are often paid outside the estate, if the money goes directly to the spouse, it becomes part of their estate — and may be taxed when they pass away.
“A spousal bypass trust keeps the lump sum out of both estates, but still allows the surviving spouse to benefit from the money,” Dawute pointed out.
He had a client recently who had a £500,000 death-in-service benefit. If this had been paid directly to their spouse, it would have raised the spouse’s estate to £1.25 million.
“Given the inheritance tax rate of 40%, this would have triggered a £200,000 IHT bill later down the line. Using a spousal bypass trust protected the payout and helped preserve the family’s wealth for future generations,” he said.
Role of the trustee
Trustees can have very wide-ranging powers and tasks, including settling tax bills and hiring investment management and legal professionals.
If the trust is discretionary (meaning they have discretion regarding the distribution of assets), they might also have to make certain decisions about how to use the trust income and/or capital.
For these reasons, many prefer to have their trust administered by professionals, paying them annual fees from the trust’s assets.
However, others looking to structure family wealth may appoint a mixture of professional and family friend trustees to create a balance of objectivity and personal knowledge of the beneficiaries’ situations and needs.
The seven year rule
If you die within seven years of making a transfer into a trust your estate will have to pay inheritance tax at the full amount of 40%.
This is instead of the reduced amount of 20% which is payable when the transfer is made during your lifetime, unless no inheritance tax was due (IHT might be due if, for example, you were making a transfer into a discretionary trust using an amount above your nil rate band).
If no inheritance tax was due when you made the transfer, but you die within seven years of the transfer being made, the value of the transfer is added to your estate when working out whether any inheritance tax is due.
If you make a gift into any type of trust but continue to benefit from the gift — for example, you give away your house but continue to live in it — you will pay 20% on the transfer and the gift will still count as part of your estate. These are known as gifts ‘with reservation of benefit’.
Advantages and disadvantages of trusts
The main advantages of using trusts in financial planning are:
- they keep wealth out of your estate for IHT planning;
- they help pass money on safely and gradually;
- to avoid probate;
- to support multi-generational financial planning.
However, the disadvantages are:
- they can be complex if not set up properly;
- trustees have legal responsibilities;
- some trusts may require tax reporting or registration;
- you can’t personally access the funds once they’re in trust.
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