Trusts are a powerful tool in inheritance tax planning, offering a way to pass on wealth while potentially keeping it outside of your taxable estate. When used correctly, they can help reduce or defer inheritance tax, provide control over how assets are distributed, and protect family wealth for future generations.
However, not all trusts work the same way, and the tax rules can be complex. Understanding how different types of trusts operate, and where they fit into a wider estate plan, is key to using them effectively to reduce inheritance tax.
Using trusts for inheritance tax planning
Using trusts to avoid inheritance tax offers a flexible way to pass on assets. It’s the perfect way to reduce taxes while maintaining a level of control over how they’re used. For those concerned about beneficiaries’ readiness, financial maturity, or complex family dynamics, trusts provide structure and protection.
All in all, trusts are considered a way to potentially reduce or avoid inheritance tax advantages. By carefully selecting the right type of trust, you can remove assets from your estate, manage future growth outside of it, and tailor how wealth is passed on.
Here’s a quick overview of why using trusts to reduce or avoid inheritance tax could be a smart move.
- Trusts move assets outside your estate in a structured way
- You can guide how and when funds are distributed
- Certain trusts start the seven-year inheritance tax clock
- Growth on trust assets is outside your estate
- Legal structures protect wealth from early mismanagement
Example: Reggie and Tilda were keen to support their children and grandchildren but didn’t want to pass on a lump sum too soon. Their adviser helped them use two trusts to pass on capital in stages — while reducing future inheritance tax.
Discounted Gift Trusts: income &immediate tax benefit
A Discounted Gift Trust (DGT) is a popular estate planning option for those who want to reduce inheritance tax while still receiving a regular income. It allows you to gift a lump sum into a trust, but retain the right to fixed withdrawals for life.
Because part of the gift is considered a retained benefit, HMRC applies a “discount” based on your age and health. This means that portion is immediately excluded from your estate. This makes DGTs particularly effective for healthy individuals with excess capital who want to balance access with tax efficiency.
Note: The size of the immediate inheritance tax reduction depends on health and life expectancy. If underwriting does not support a strong actuarial discount, the excluded portion may be smaller than expected, or in some cases, there may be no immediate exclusion at all.
The discounted portion is outside your estate immediately
- The remainder may be tax-free after seven years
- You keep an income stream, which can be tax-free
- You lose access to the lump sum itself
- Works well for healthy individuals with surplus capital
Example: Anita, aged 65, gifted £200,000 into a DGT and chose to take £8,000 a year. HMRC applied a £60,000 discount, which reduced her estate’s taxable value instantly.
Loan Trusts: Control and access without growth
A loan trust offers a straightforward way to pass on future investment growth without giving up access to your original capital. Instead of gifting a lump sum outright, you lend money to a trust, which can be repaid to you at any time.
While the loan itself remains part of your estate, any growth on the invested funds sits outside it, making loan trusts a useful option for inheritance tax planning where flexibility and capital access are important.
- There’s no immediate inheritance tax saving
- You keep full access to the original loan
- Future growth escapes inheritance tax
- Works well when you want control and flexibility
- Popular for cautious estate planning strategies
Example: Jean lent £300,000 to a Loan Trust invested in a bond. Ten years later, the bond had grown to £420,000. Her estate still included the £300,000, but the £120,000 gain was not taxable.
Learn more: Loan Trusts vs Discounted Gift Trusts
Using Flexible Reversionary Trusts to avoid inheritance tax: optional access
Flexible Reversionary Trusts are designed for individuals who want to gradually transfer wealth out of their estate for inheritance tax purposes, without giving everything away at once.
The initial gift into a Flexible Reversionary Trust starts the inheritance tax seven-year clock. If the settlor dies within seven years, the gift portion may still form part of the estate, subject to taper relief rules.
These trusts allow for scheduled payments or access points, giving you the flexibility to retain potential benefits over time. All of this while progressively reducing your taxable estate. By carefully structuring when and how assets revert or remain in trust, FRTs can offer a balanced solution between control, access, and long-term inheritance tax mitigation.
Key fact: The trustees, not the settlor, decide whether funds are paid to you, to beneficiaries, or left in trust at each maturity. This means you retain flexibility, but not personal unilateral control over withdrawals.
- Set up using an investment bond with fixed maturities
- You have the option, not obligation, to withdraw funds
- Offers inheritance tax savings if maturities are left untouched
- Good for uncertain future needs or family complexities
- Can be paired with other planning tools
Example: Mark and Inaya set up a Flexible Reversionary Trust with £500,000. Each year, 10% matured. They took no withdrawals, allowing the full amount to remain in trust, outside their estate, after seven years.
Discretionary trusts: long-term family protection
When it comes to avoiding inheritance tax, Discretionary Trusts are a powerful tool for those looking to protect family wealth across generations while retaining flexibility over how and when beneficiaries receive support. Rather than naming fixed entitlements, you give trustees the discretion to decide who benefits, when, and by how much.
This makes them ideal for complex family situations, vulnerable beneficiaries, or where future needs are uncertain. From an inheritance tax perspective, discretionary trusts can also help limit exposure by keeping assets outside of individual estates, provided they’re set up and managed within the relevant thresholds.
Discretionary trusts offer the most flexibility but also come with more rules. You choose the trustees and set out how money can be used, without giving direct access to beneficiaries.
- You choose who benefits and when
- Trustees manage the assets in line with your wishes
- Used for complex family setups or vulnerable beneficiaries
- Potential for inheritance tax charges every 10 years
- Still valuable for protecting wealth and reducing risk
Example: Terence wanted to provide for three grandchildren but didn’t want the money accessed before they were 30. A discretionary trust lets him do that, with trustees holding full control until the right time.
Discover other trust options in our guide to the types of trusts for inheritance tax planning. You gain a bit more insights how these trusts are used to avoid inheritance tax.
When do trusts reduce inheritance tax?
The benefits of using trusts to avoid inheritance tax depend on the type of trust and how it’s structured. While some trusts, like Discounted Gift Trusts can offer immediate tax advantages, most provide tax efficiency over time by removing future growth from your estate or starting the seven-year clock on gifts.
Timing, compliance, and proper setup are crucial, as incorrect use can lead to unexpected tax charges. Understanding when and how each trust delivers its tax mitigation benefit is key to using them effectively in estate planning.
- Gifts into trusts may be exempt after seven years
- Growth inside trusts is not part of your estate
- Trusts can use life insurance to cover potential tax bills
- Some trusts offer instant IHT benefits (like DGTs)
- Compliance matters, incorrect use can trigger tax penalties
Sophie set up a discretionary trust funded by a bond and added life cover to cover any tax if she died within seven years. Her plan gave flexibility, tax efficiency, and peace of mind.
Are there any drawbacks to using trusts to avoid inheritance tax?
While trusts can be highly effective for inheritance tax planning, they’re not without drawbacks. Setting up a trust involves giving up some control or access to assets, and the structure must be carefully managed to maintain its tax advantages.
Trustees take on legal duties, and ongoing administration, along with possible registration and reporting requirements, can add complexity and cost. For the right individual, trusts offer powerful benefits, but they must be used with care and professional guidance to avoid unintended consequences.
- Some trusts involve losing access to capital
- Trustees have legal responsibilities and duties
- You may need to register the trust with HMRC
- Administration and costs can increase over time
- If mismanaged, you could lose tax advantages
Work with an adviser who understands your goals. Trusts offer powerful benefits, but they’re not plug-and-play products.
Using trusts to avoid inheritance tax: Summary
Trusts are a versatile and effective tool to reduce or avoid inheritance tax as they allow individuals to pass on wealth while potentially removing it from their taxable estate. Different types of trusts, such as Discounted Gift Trusts, Loan Trusts, Flexible Reversionary Trusts and Discretionary Trusts, offer varying levels of access, control and tax efficiency depending on how they are structured and used.
Some trusts provide immediate inheritance tax benefits, while others help reduce liability over time by removing future growth from the estate or starting the seven-year exemption period.
Each type of trust serves different needs, from providing a steady income while reducing the estate’s value to protecting assets for vulnerable beneficiaries.
However, trusts must be carefully set up and managed, as incorrect use can lead to tax penalties or lost reliefs. Trustees carry legal responsibilities, and ongoing administration can add cost and complexity. While trusts offer powerful estate planning advantages, professional advice is essential to ensure they are used effectively and in line with personal and family goals.