Trusts for Children: When They Work, What They Cost, and What to Put in Them
A parent transferring £500,000 of investments into a discretionary trust for their children pays an immediate 20% entry charge on the value above the £325,000 nil rate band. The trust faces a periodic IHT charge of up to 6% every ten years on the value above the nil rate band, plus exit charges on capital distributions. Income generated by the trust is taxable at trust rates of around 39-47% depending on the type of income and tax year. Done well, the structure is genuinely powerful for HNW estate planning. Done without engaging with these mechanics, it produces unintended tax bills that often exceed the IHT saving the trust was supposed to deliver.
For most of the last twenty years, trusts for children have been one of the standard tools in UK HNW estate planning. The structural appeal is clear as capital transferred during life can pass to children with structural control over how and when it's used, can be protected from third party claims like divorce or creditor action, and can be removed from the parent's IHT estate over the seven year clock.
But trusts are also a uniquely complex part of the UK tax code. The relevant property regime applies separate IHT charges to discretionary trusts. Income tax on income generated within the trust is at trust rates that are much higher than personal rates. The settlements legislation taxes parental gifts to minor children differently from other transfers. And the 2024-2026 BPR reforms have further tightened the regime for trusts holding qualifying business assets.
For HNW families considering trusts for children, the practical question isn't "should we set one up", for many it is a useful structure, it's "what type, funded with what, with what conditions, and when". This article works through those questions.
The three trust types and where each fits
For trusts for children, three structures account for substantially all the practical use cases.
Bare trusts
The simplest structure. Assets are held in the name of a trustee for the benefit of a named child, who has absolute legal entitlement to the assets. At 18 the child can call for the assets unconditionally. From a tax perspective, the assets are treated as belonging to the child from the outset, income and gains are the child's, not the trustee's, subject to the parental settlements rules below.
Bare trusts work well for clients who want a clean, low overhead way to gift capital to a specific child, accept the child will have full control at 18, and want income and gains taxed at the child's rates. They do not work where the parent wants ongoing control beyond 18, where there are concerns about the child's maturity at age 18, or where the gift is large enough that handing over at 18 would be inappropriate.
Discretionary trusts
The dominant structure for HNW families wanting genuine control. The trustees have discretion over which beneficiaries (typically all children, sometimes including their spouses or descendants) receive income or capital, and when. The settlor sets the framework through a deed of trust and a non-binding letter of wishes, the trustees apply judgement.
Discretionary trusts work well for clients who want flexibility to adjust distributions across children whose needs differ (one buying a property, another funding a business, another with no current need), protection of capital from third party claims (divorce, creditor action, mental incapacity, child's own poor financial decisions), and ability to retain the structure beyond the children's lifetimes if appropriate. They come with materially more tax complexity than bare trusts, more administrative cost, and the requirement for trustees who genuinely understand and discharge their duties.
Interest in possession trusts
Less commonly used for children specifically. The dominant use case is on death, a surviving spouse receives the trust income for life, with capital passing to children on the spouse's death. For lifetime trusts for children specifically, IIP trusts are less flexible than discretionary trusts and have fewer practical advantages. They occasionally come up in family business succession planning where one beneficiary needs current income (e.g. a child running the business) and others have future capital interests.
The tax framework
Tax issues shape whether a trust for children works structurally.
The relevant property regime on discretionary trusts
This is an important framework most clients setting up discretionary trusts don't engage with properly.
When assets are settled into a discretionary trust above the nil rate band (£325,000), an immediate 20% IHT entry charge applies (chargeable lifetime transfer). For a £500,000 settlement, that is £35,000 of IHT payable at outset.
Once the assets are inside the trust, a periodic charge applies every ten years. The maximum headline rate is 6% of the value above the nil rate band, though effective rates are often lower due to the way the charge is calculated. For a trust valued at £1m at the ten year anniversary, the charge is roughly £40,000 (6% of £675,000).
Exit charges apply when capital is distributed to beneficiaries. The rate depends on when the distribution occurs relative to the ten year anniversaries and what charges have already been paid.
Done well, these charges are still materially less than the 40% IHT charge that would apply to the same assets in the estate. For a £500,000 settlement that survives the seven year clock, the £35,000 entry charge plus periodic charges across the life of the trust typically totals less than £200,000, versus £200,000 of IHT if the same £500,000 had remained in the estate above the nil rate band. The structure produces real planning value.
But it requires the client to understand the charges before settling. Many trusts are set up without proper engagement with the regime, and the family is surprised by the periodic charge ten years later.
Trust rates of income tax
Income generated within a discretionary trust is taxed at trust rates, around 39-47% depending on the type of income and tax year. These are punitive rates designed to discourage using trusts as income tax shelters.
For trusts holding investment portfolios that generate substantial income, the tax efficiency is materially worse than holding the same investments outside the trust. Trustees can mitigate this by accumulating income inside the trust rather than distributing it (avoiding the immediate trust rate but creating a periodic charge issue), distributing income to beneficiaries who can reclaim some of the tax credit, or holding assets that don't generate income (growth orientated equities, life insurance bonds, capital only investments).
For HNW clients with substantial liquid wealth, the income tax point often steers the funding decision, trusts work better when funded with assets that produce capital growth rather than current income.
Funding decisions: What to put in the trust
The choice of funding asset interacts with all three of the tax issues above. Three common approaches:
Cash and listed investments
Simple but income generating. Settled into a discretionary trust above the nil rate band, this triggers the 20% entry charge plus future periodic charges, and the income generated within the trust is taxable at trust rates. Works for clients who genuinely want the discretion benefits and accept the tax friction. Does not work well for very income orientated investors.
Investment bonds
Onshore or offshore investment bonds held in trust avoid the trust rate income tax issue because no income is deemed to arise within the bond. The chargeable event regime applies on surrender, with the gain taxed against the relevant tax position at that point. I covered this in detail in my offshore bonds article. For trusts holding investment capital, bonds are often the wrapper of choice precisely because they sidestep the trust rate income tax problem.
Qualifying business assets
Assets qualifying for BPR (private trading businesses, AIM shares, EIS) historically attracted 100% IHT relief, which meant they could be settled into trust without the 20% entry charge applying to the value of the qualifying assets. The 6 April 2026 BPR reform changes this materially, only the first £2.5m of qualifying assets attracts 100% relief, with 50% relief above. AIM shares no longer benefit from the £2.5m allowance and receive 50% relief from the first £1.
For trusts established by the same settlor on or after 30 October 2024, the £2.5m allowance is shared across multiple trusts created by that settlor. This closes the previous strategy of creating multiple trusts to multiply the allowance.
These rules are subject to final legislation and HMRC guidance, so the details should be checked before implementing any structure.
Life insurance written into trust
Premiums paid for a life insurance policy held in trust are themselves potentially gifts to the trust, but where they fall within the gifts out of normal expenditure exemption, the structure is highly tax efficient. I covered the maths in my Life Insurance for Inheritance Tax piece.
Trustee selection, the part clients tend to underweight
Trustees discharge a real fiduciary duty. They are legally responsible for prudent investment, fair distribution between beneficiaries, tax compliance, and acting in accordance with the trust deed. The choice of trustees is structurally important and often given less thought than it deserves.
For most HNW family trusts, the practical answer involves three components:
One or two family members or close personal advisors (often the settlor and a trusted friend or family member at outset, with provision for successor appointments).
A professional trustee, particularly for larger or more complex trusts where the administrative and compliance burden is meaningful.
Clear successor trustee provisions in the trust deed, so that the structure continues to function as the original trustees age out.
The professional trustee question is genuinely a judgement. Professional trustee fees on a £1m trust typically run £3,000 to £8,000 a year. For trusts that will run for several decades, that is a meaningful annual cost, but the alternative is family members or friends carrying real legal liability for decisions they may not be qualified to make.
Conditions and the letter of wishes
The trust deed creates the legal framework. The letter of wishes, a non-binding document from the settlor to the trustees gives guidance on how the discretion should be exercised.
The letter of wishes is where most of the practical thinking happens. Common provisions include educational support priorities (university fees, postgraduate study, professional qualifications), property purchase support (deposits, mortgage assistance for first time buyers), business venture support (capital for genuine entrepreneurial ventures, with clear criteria), emergency or hardship provisions, and equality between siblings, important to be explicit about how unequal needs at different ages should be reconciled.
The letter of wishes can be updated by the settlor as circumstances change. Unlike the trust deed, it doesn't require a formal deed of variation, which makes it the right place for evolving family preferences.
FICs vs trusts: When each is the right answer
For HNW families with substantial capital to transfer to children, the comparison between a trust and a Family Investment Company (FIC) is worth flagging.
FICs work better for:
Larger transfers (typically £2m+) where corporate flexibility justifies the setup and ongoing administration.
Investment orientated portfolios where dividend distributions and corporate rate income tax can be more efficient than trust rates.
Families wanting to retain ongoing influence over investment decisions through directorship while transferring economic value through share structure.
Multi-generational succession where the corporate vehicle persists across generations.
Trusts work better for:
Smaller transfers where corporate overhead isn't justified.
Situations where the beneficiaries are still minors and corporate shareholding would be impractical.
Cases where the flexibility on distribution timing matters more than control of investment policy.
Families where the legal protection of the trust structure (creditor protection, divorce protection, mental capacity protection) is required.
For many HNW families, the answer involves both, a trust for younger children and a FIC for older children with active business interests.
What this means in practice
If you are reading this because you are considering setting up a trust for your children, three structural questions are worth working through:
What are you trying to achieve, and is a trust the right vehicle? Specific goals (tax efficiency, control over distribution, asset protection, multi-generational succession) point to different structures. A bare trust solves a different problem from a discretionary trust, and a JISA solves a different problem still. Define the goal first, then choose the structure.
Have you engaged with the relevant property regime if you're considering a discretionary trust? The 20% entry charge on the value above the nil-rate band, the periodic charges every ten years, and the exit charges on distributions are not optional. The structure can still produce meaningful planning value, but only if the charges are understood and modelled before the trust is created.
Have the funding decision and the income tax position been considered together? The trust rates of income tax (around 39-47% depending on the type of income and tax year) make trust held income generating assets meaningfully less efficient than other wrappers. Investment bonds, capital growth investments, or business assets often work better than direct income generating portfolios.
The right answer for most HNW families considering trusts for children involves coordination between the financial planner, a specialist trust solicitor, and a tax adviser. The structures interact across multiple disciplines and the decisions made at outset compound for decades.