Using Trusts to Reduce Inheritance Tax

What is a trust and how does it reduce inheritance tax?

A trust is a legal arrangement under which assets are transferred to trustees, who hold them for the benefit of named beneficiaries. Once an asset has been placed into trust correctly, it is no longer part of the personal estate for inheritance tax purposes - subject to certain rules around the type of trust and the seven-year survival period.

That, in plain terms, is the core mechanism: moving capital outside the estate before death so it is not subject to the 40% charge that would otherwise apply. The right structure of trust depends on what the asset is, who the beneficiaries are and what control the settlor wants to retain.

Discretionary trusts

A discretionary trust gives the trustees flexibility to decide which beneficiaries benefit, how much and when. That flexibility makes discretionary trusts particularly useful for inheritance tax planning - and particularly useful for families where children's circumstances are likely to change.

Assets placed into a discretionary trust fall outside the estate after seven years, provided the transfer does not exceed the available nil-rate band at the time of the gift. Larger transfers may be subject to an entry charge of 20% on the excess above the nil-rate band - though even this is half the eventual IHT rate, so for the right estate it remains efficient.

Discretionary trusts also carry ten-yearly and exit charges that need to be planned for. The benefit is control: assets are protected from beneficiaries' divorces, bankruptcies and tax positions while remaining usable for their benefit.

Life interest trusts

A life-interest trust gives one beneficiary - typically the surviving spouse - the right to receive income from the trust assets, or to occupy the trust property, during their lifetime. The capital is preserved for other beneficiaries (usually the children) on the life tenant's death.

Life-interest trusts are commonly used to provide for a surviving spouse while ensuring the capital ultimately passes to the children, rather than being exposed to a second IHT charge on the spouse's death, absorbed into a future spouse's estate, or claimed in a future divorce.

On first death within a marriage, a life-interest trust over the deceased's share of the family home is one of the most commonly used IHT and family-protection structures in standard estate planning.

Insurance trusts - putting life insurance outside the estate

Life insurance held personally forms part of the estate on death and adds to the inheritance tax calculation - even though the policy was intended to provide for the family rather than for HMRC. Writing the policy into trust removes it entirely.

The trust receives the payout directly from the insurer, the trustees distribute it to the named beneficiaries, and the proceeds never pass through the estate or attract inheritance tax. It is one of the simplest and most impactful pieces of IHT planning available - and one of the most commonly missed.

Deed of variation

A deed of variation allows a beneficiary who has inherited assets to redirect some or all of them to other beneficiaries, within two years of the date of death. The variation is treated as if the deceased had made the redirection in the original Will - including for inheritance tax purposes.

Deeds of variation are a powerful post-death planning tool. They can be used to direct assets into trust for the next generation, to skip a generation entirely, to make use of nil-rate bands that would otherwise be wasted, or simply to correct an inefficient original distribution. The two-year window matters - the planning has to happen quickly after death.

Trust planning and the April 2027 pension changes

The interaction between trust arrangements and pension death benefits is complex and is changing materially from April 2027, when unused pension assets fall inside the taxable estate. Existing trust nominations on pension schemes may need to be reviewed and restructured to remain effective under the new rules. Read the detailed April 2027 article →

Flexible Reversionary Trust

A Flexible Reversionary Trust allows you to move capital outside your estate today while retaining the trustees' discretion to release payments back to you if your circumstances change. It is particularly relevant for families affected by the April 2027 pension changes, where a previously tax-efficient asset will suddenly become part of the taxable estate. Read more about Flexible Reversionary Trusts →