For many generations, trusts have played a key role in passing on wealth to beneficiaries and reducing one's inheritance tax liability in the process.

They're tax-efficient but can also be extremely complex without expert help, which might also explain why they're underused.

For example, more than one in four people didn't know they could write their life insurance policies into trusts in 2018/19.

That resulted in more than 6,000 estates unnecessarily paying inheritance tax, worth more than £280 million - and it could've been legally avoided.

Many people who buy life insurance are not aware it's included in their estate, and could end up being taxed at 40% if it's not put into trust.
Inheritance tax receipts are on the rise, and that trend looks set to continue with the nil-rate and the residence nil-rate bands both frozen until 2026.

HMRC collected £2.1 billion of inheritance tax between April and July 2021, £500m more than the same period last year.

With that in mind, let's try and demystify trusts and the role they can play in reducing the value of your estate to mitigate against inheritance tax.

The role of a trust

Assets such as money, property, land and investments can be put into a trust, subject to certain conditions being met.

The settlor has an asset written into trust, a trustee is then responsible for managing the assets in trust, and a beneficiary is the recipient of the asset.
Once an asset goes into trust, the settlor no longer owns it. Because of that, the asset no longer counts towards the value of their estate.

If the value of the settlor's estate is less than £325,000, the estate will not be liable to inheritance tax. If the estate is worth more, it may be taxed at 40%.

The settlor can set the rules of the trust and must appoint a trustee, who will be the guardian of the asset until the beneficiary can access it.

Types of trust

Bare trusts are the most basic type of trust, in which the named beneficiaries inherit the trust at the age of 18. These are often inheritance tax-free if the settlor transfers an asset into trust seven years before death.

Usually, beneficiaries can receive income from interest-in-possession trusts but they can't access the assets which generate that income. Investments placed into trust, for example, are suitable for these trusts.

Discretionary trusts result in the named trustee determining how, when and to whom any assets are distributed from a pool of beneficiaries created by the settlor.

It's possible to combine elements of more than one type of trust via a mixed trust, but these often become complicated and require the advice of an expert.

Potential benefits

Every time an asset is written into trust, it will reduce the value of the settlor's estate if certain conditions are met as they no longer own that asset. This has a domino effect on reducing the inheritance tax liability.

Trusts allow a degree of control to be exercised over family assets, with the settlor determining the rules. For example, the settlor can prevent the beneficiary from inheriting an asset until they reach a certain age.

Using a trust can also override the need for a lengthy probate process, potentially allowing the direct transfer of assets held in trust to beneficiaries.

Speak to us about inheritance tax planning.