Trusts to avoid inheritance tax: A strategic shield for your wealth

Inheritance Tax (IHT) is often referred to as a "voluntary tax", not because it's optional, but because with smart planning, much of it can be mitigated or avoided altogether.

For many affluent families, trusts play a crucial role in shielding wealth, providing control over how assets are distributed, and significantly reducing exposure to tax.

If your estate is likely to exceed the IHT threshold (£325,000 per individual or £650,000 for a couple, with potential for an additional £175,000 each for a family home passed to direct descendants), planning ahead is essential. Without the right structures in place, up to 40% of your estate could be lost to HMRC.

What is a trust?

A trust is a legal arrangement that enables one party (the settlor) to transfer assets to a second party (the trustees) who manage those assets on behalf of a third party (the beneficiaries). While trusts can serve many purposes from protecting assets to supporting vulnerable beneficiaries, their role in inheritance tax planning is particularly powerful.

Once assets are placed into a trust, and depending on the type of trust and how it is set up, they may no longer be considered part of your estate for IHT purposes. If you survive for seven years after making the transfer, the value of those assets is usually excluded from your estate, helping to significantly reduce your overall liability.

Popular trust structures for IHT planning

1. Discretionary trusts

Discretionary trusts are one of the most commonly used vehicles in estate planning. They give trustees the flexibility to decide how and when beneficiaries receive funds. This can be particularly useful if:

• You wish to support children or grandchildren at specific life stages (e.g. education, marriage, buying a home)

• You want to protect beneficiaries who may be financially inexperienced or vulnerable

• You’re concerned about family disputes or divorces affecting inheritance

Assets transferred into a discretionary trust are generally treated as Potentially Exempt Transfers (PETs). If you survive for seven years, the value of the gift falls outside your estate for IHT purposes. However, these trusts may be subject to periodic and exit charges, typically a maximum of 6% every ten years.

2. Loan trusts

Loan trusts offer a smart way to reduce IHT without giving up control of your capital. Here’s how it works:

• You lend a sum of money to a trust

• The trust invests that money for the benefit of your chosen beneficiaries

• The growth on the investment sits outside your estate for IHT purposes, while the original loan remains part of your estate

You can repay yourself the loan over time, either in full or via income. This setup is ideal for individuals who want to pass on investment growth tax-efficiently but still retain access to their original capital.

3. Gift and loan arrangements

A hybrid of outright gifts and loan trusts, gift and loan arrangements allow you to:

• Make an initial gift into a trust, removing it from your estate

• Simultaneously loan an additional sum to the same trust

This approach enables part of your capital to start escaping the IHT net immediately, while the loan gives you continued access to funds. It’s a flexible solution that balances control, accessibility, and tax efficiency.

Why use trusts in estate planning?

Trusts aren’t just about reducing tax burdens, they’re also about control, protection, and long-term stewardship of wealth. Used properly, trusts can help you:

• Maintain control: You can specify how assets are managed, when beneficiaries gain access, and under what circumstances funds are distributed.

• Protect beneficiaries: Trusts are ideal for supporting minors, beneficiaries with disabilities, or those who may not yet be financially responsible.

• Mitigate IHT: Strategic use of trusts can remove assets from your taxable estate, reducing or even eliminating your IHT liability.

• Safeguard family wealth: Trusts can offer protection against marital breakdowns, creditor claims, and future tax changes.

Key considerations when using trusts

While trusts are powerful tools, they must be used carefully. Consider the following:

• Tax implications: Some trusts can trigger income tax or capital gains tax, depending on the assets held and distributions made.

• Periodic charges: Discretionary trusts, for example, may incur a 10-yearly IHT charge of up to 6% on the value above the nil-rate band.

• Administration: Trustees have legal duties, including tax reporting and record-keeping. Professional advice is essential to ensure compliance.

• Changes in legislation: Tax rules can change. Regular reviews of your trust arrangements ensure they remain effective and compliant with current law.

Trusts and IHT: A long-term strategy

It’s important to view trust planning not as a one-time fix, but as part of a broader, ongoing estate planning strategy. The right trust structure depends on your unique circumstances, your assets, your family dynamics, and your long-term intentions.

Incorporating trusts into your estate plan allows you to shape your legacy with precision. It gives you the power to support future generations, protect vulnerable family members, and minimise the impact of taxation. More than that, it gives you peace of mind that your wealth will do what you intended long after you're gone.

Thinking about using trusts in your estate plan?

Trusts can seem complex, but with the right guidance, they become an invaluable part of your financial toolkit. Whether you're looking to reduce your IHT liability, provide for future generations, or retain control over your legacy, we’re here to help.

Let’s explore how trusts can support your estate planning goals. Book a consultation today, and we’ll help you build a strategy that works for you and your family.