Trusts in Financial Planning: Control First, Tax Second
Trusts are often discussed as if they are primarily tax-planning tools which can be misleading.
At their core, trusts are legal arrangements that separate legal ownership from beneficial enjoyment. They can help someone control who benefits from assets, when they benefit, how much they receive and who makes decisions on their behalf.
That can be useful where someone wants to:
Provide for children without giving them immediate control of a large sum
Protect assets for younger or vulnerable beneficiaries
Give trustees discretion over future payments
Provide income to one person whilst preserving capital for another
Manage how wealth passes between generations
Place life assurance proceeds outside the estate and make them available quickly
Tax is still extremely important, but it should usually be viewed as a consequence of the structure rather than the sole reason for using it.
A trust that produces a favourable tax outcome but gives the client the wrong level of access, control or flexibility is unlikely to be good financial planning.
The right starting point is therefore:
What is the client actually trying to achieve?
Only once that is clear should the adviser consider the appropriate trust structure and the tax treatment that follows.
The Basic Parties to a Trust
Most trusts involve three parties.
The settlor is the person who places assets into the trust.
The trustees become the legal owners of those assets and are responsible for managing them in accordance with the trust deed.
The beneficiaries are the people who can ultimately benefit from the trust.
The key concept is that legal ownership and beneficial ownership can be separated.
For example, trustees might legally own an investment portfolio, whilst the economic benefit is intended for the settlor's children.
That separation is one of the main reasons trusts are useful.
Bare Trusts
A bare trust is one of the simplest trust structures.
The beneficiary is absolutely entitled to both the capital and income of the trust.
The trustee may legally hold the assets, but the beneficiary is effectively treated as the underlying owner and is therefore generally liable for any Income Tax and Capital Gains Tax arising.
For example, a grandparent might invest £50,000 into a bare trust for a grandchild.
The trustees hold and manage the investment whilst the grandchild is young, but the assets ultimately belong to that grandchild.
For Inheritance Tax purposes, a transfer into a bare trust will normally be treated in much the same way as a direct gift to the beneficiary.
It is generally a potentially exempt transfer, or PET.
If the donor survives seven years from the date of the gift, the transfer will normally fall outside their estate for IHT purposes.
The trade-off is control.
A bare trust does not allow the trustees to permanently withhold the money simply because they think the beneficiary is not ready to receive it.
That makes bare trusts relatively simple, but less flexible than discretionary trusts.
Interest in Possession Trusts
An Interest in Possession (IIP) trust gives one beneficiary, known as the life tenant, an immediate right to benefit from the trust. This will commonly be an entitlement to income, although it can include a right to occupy a property. The trust capital ultimately passes to the remaindermen.
Simple Example
A husband leaves £500,000 of investments in trust. His wife receives the income for the rest of her life. When she dies, the remaining capital passes to their children.
The wife is the life tenant and the children are the remaindermen. The wife benefits from the assets but does not own the trust capital outright, so she cannot redirect it through her own Will. However, the trust deed may give the trustees powers to advance capital to her.
For IHT, 22 March 2006 is the key dividing line:
Pre-22 March 2006 IIPs – The trust assets are generally treated as part of the life tenant’s estate for IHT purposes.
Post-22 March 2006 lifetime IIPs – These generally fall within the relevant property regime and are taxed broadly like discretionary trusts. This can result in an entry charge, ten-year periodic charges of up to 6% and exit charges.
Post-22 March 2006 IIPs created on death – These may qualify as Immediate Post-Death Interests (IPDIs). The trust property is then generally treated as part of the life tenant’s estate for IHT rather than being subject to the relevant property regime.
A simple way to remember this is:
Old IIP → Life tenant’s estate
New lifetime IIP → Broadly like a discretionary trust
New IIP on death (IPDI) → Life tenant’s estate
IPDIs and the Family Home
An IPDI is commonly used in a Will to protect the surviving spouse or civil partner whilst preserving capital for children.
For example, the deceased’s share of the family home could pass into an IPDI under which:
The surviving spouse has the right to live in the property for life.
The trustees hold and control the deceased’s share.
The trust contains provisions dealing with a sale, replacement property and payment of expenses.
The deceased’s share ultimately passes to the children when the surviving spouse dies.
If the home is owned as joint tenants, it passes automatically to the survivor and cannot pass into the Will trust. The joint tenancy may therefore need to be severed, changing the beneficial ownership to tenants in common. Each owner’s share can then pass under their Will.
Severance does not physically divide the property or prevent the couple from continuing to live in it. It changes how the beneficial ownership passes on death and should be coordinated with properly drafted Wills.
Where the surviving spouse receives a qualifying IPDI, the spouse exemption will normally apply on the first death, subject to the usual conditions. However, the trust property is generally aggregated with the life tenant’s estate when they later die. An IPDI is therefore primarily a way of protecting the destination and control of capital, rather than automatically eliminating IHT.
It can protect against the deceased’s share being redirected following the survivor’s remarriage or a change to their Will. However, it should not be described as guaranteed protection from care fees because the trust terms, the survivor’s rights and the local authority’s deprivation-of-assets rules must all be considered.
The IHT treatment of any IIP trust can be complex because it depends on:
When the trust was created.
Whether the interest arose during lifetime or on death.
The precise rights given to the life tenant.
Whether the interest qualifies as an IPDI or another specially treated interest.
The identity and tax status of the beneficiaries.
In practice, the trust deed, Will, property ownership and date of creation must all be reviewed before reaching a conclusion. Legal and tax advice will normally be required.
Discretionary Trusts
A discretionary trust gives the trustees much more control.
Instead of a beneficiary having an automatic right to income or capital, the trustees decide:
Who receives money
When they receive it
How much they receive
Whether income or capital should be retained
For example, parents may place £300,000 into a discretionary trust for their children and grandchildren.
The trust deed could include several potential beneficiaries without giving any of them an immediate entitlement.
The trustees might decide to pay university costs for one beneficiary, contribute towards a property purchase for another and retain the remainder for future generations.
This flexibility is often the real planning benefit.
The tax treatment is more complicated, but the starting point should still be the client's objectives rather than the tax rules.
PETs and CLTs
One of the most important trust-planning distinctions is the difference between a PET and a chargeable lifetime transfer.
Potentially Exempt Transfers
A PET commonly arises when someone:
Gives assets directly to another individual
Places assets into a bare trust
There is normally no immediate IHT charge.
If the donor survives seven years, the transfer normally becomes fully exempt.
If they die within seven years, the transfer becomes chargeable and is brought back into the IHT calculation.
Chargeable Lifetime Transfers
A transfer into a discretionary or other relevant property trust will generally be a chargeable lifetime transfer, or CLT.
This means the transfer immediately uses the settlor's available nil-rate band.
Suppose someone with no earlier chargeable transfers places £300,000 into a discretionary trust. If they have the full £325,000 nil-rate band available, the transfer may not create an immediate lifetime IHT charge. However, it has still used £300,000 of their nil-rate band for the purposes of calculating later lifetime transfers.
If instead they transfer £500,000, the amount above the available nil-rate band will normally create an immediate lifetime IHT charge of 20%.
When working out how much nil-rate band is available for a new CLT, you look back at earlier CLTs made in the previous seven years. Previous PETs are not taken into account when calculating the immediate lifetime IHT charge, because they remain potentially exempt whilst the donor is alive. PETs can, however, become relevant if the donor dies within seven years of making them.
The key point is therefore:
Bare trust gift = usually PET
Discretionary trust gift = usually CLT
And for lifetime IHT:
New CLT = look back seven years at previous CLTs, not PETs.
The Seven-Year Rule
Most people are familiar with the idea that lifetime gifts become less relevant for IHT once seven years have passed.
For PETs, surviving seven years generally means the gift falls outside the estate.
For CLTs, earlier chargeable transfers also cease to affect later cumulative calculations once they fall outside the relevant seven-year window.
However, there is an additional complication that can require advisers to look further back.
The Fourteen-Year Rule
The so-called fourteen-year rule usually arises where there is:
An earlier CLT, followed by a PET, followed by death
For example:
Year 0: £300,000 is transferred into a discretionary trust.
Year 6: £300,000 is gifted outright to a child.
Year 10: the donor dies.
Assume these figures are after any available exemptions and reliefs.
The trust transfer happened ten years before death, so it might appear irrelevant.
However, the gift to the child was made only four years before death and therefore becomes chargeable.
When calculating the tax attributable to that failed PET, earlier chargeable transfers in the seven years before the PET may still need to be considered.
That can effectively pull the earlier trust transfer back into the calculation.
The important distinction is that the earlier CLT is not itself becoming taxable again.
Instead, it can affect the nil-rate band available to the later failed PET and therefore how much IHT is due on the PET and the rest of the estate.
Relevant Property Trusts: Entry, Ten-Year and Exit Charges
Most modern discretionary trusts fall within the relevant property regime.
A simple way to remember the IHT structure is:
Assets enter the trust
Assets remain in the trust
Assets leave the trust
Each stage can potentially create an IHT consequence.
Entry
The initial transfer into the trust is generally a CLT.
If the transfer exceeds the settlor's available nil-rate band, an immediate lifetime IHT charge of 20% may arise.
Ten-Year Charges
Why Is There a Charge Every Ten Years?
The relevant property regime is designed around the broad principle that wealth would ordinarily face a 40% IHT charge when it passes from one generation to the next. A generation is often illustrated as approximately 30 years.
Because a trust does not die, assets could otherwise remain within it for several generations without facing the IHT charge that might arise if they were owned personally. The ten-year charge therefore acts as a periodic substitute.
HMRC describes the broad design as:
A potential 20% lifetime charge when assets enter the trust
Followed by three potential ten-year charges of up to 6% over 30 years
The 6% charges compound because each charge reduces the amount remaining:
After 10 years: £100 × 94% = £94
After 20 years: £94 × 94% = £88.36
After 30 years: £88.36 × 94% = £83.06
Therefore, three maximum 6% charges would remove approximately:
£100 − £83.06 = £16.94, or 16.94%
If a 20% lifetime entry charge is also included:
£100 × 80% × 94%³ = £66.45 remaining
The combined effective tax would therefore be approximately:
£100 − £66.45 = £33.55, or 33.55%
This is still less than a single 40% IHT charge. In practice, the tax may be lower again because the available nil-rate band and relevant reliefs can reduce both the entry and periodic charges.
The ten-year regime is therefore intended to make the taxation of long-term trusts broadly comparable to IHT arising once a generation, rather than to impose a full 40% charge every 30 years.
Relevant property trusts can also face an IHT charge every ten years.
Simplified Ten-Year Charge Example
The maximum effective rate is broadly 6%, although the actual calculation is more complicated. Importantly, the charge is not automatically 6% of the entire trust fund. It depends on factors such as:
The value of the trust
The available nil-rate band
Earlier chargeable transfers
Additions to the trust
Any relevant reliefs
Assume that, on its tenth anniversary:
A discretionary trust is worth £500,000
The full £325,000 nil-rate band is available
There are no earlier transfers, additions or reliefs to consider
The value exceeding the nil-rate band is:
£500,000 − £325,000 = £175,000
The simplified ten-year charge is:
£175,000 × 6% = £10,500
This is equivalent to an effective rate of:
£10,500 ÷ £500,000 = 2.1% of the total trust value
Therefore, the trustees pay £10,500, rather than 6% of the entire £500,000 fund, which would have been £30,000.
For most financial-planning discussions, it is enough to understand that discretionary trusts can face a periodic IHT charge at each ten-year anniversary, but the 6% rate generally applies only to the value that is effectively above the available nil-rate band.
Exit Charges
An exit charge can also arise when assets leave a relevant property trust. For example, trustees might distribute capital to a beneficiary between ten-year anniversaries.
The exit-charge rate is generally based on the trust’s effective rate at the previous ten-year anniversary and the number of complete three-month periods that have elapsed.
Continuing the example, suppose the trustees distribute £100,000 just over two years after the tenth anniversary:
Effective ten-year rate: 2.1%
Complete quarters elapsed: 8 out of a possible 40
Exit-charge rate: 2.1% × 8/40 = 0.42%
Exit charge: £100,000 × 0.42% = £420
This is a simplified illustration. The precise calculation can be affected by later additions, reliefs and whether the trustees bear the tax.
The simple rule to remember is:
Discretionary trusts can potentially face entry, ten-year and exit charges.
Income Tax in a Discretionary Trust
Discretionary trusts are generally taxed at relatively high rates.
For 2026/27, accumulation and discretionary trusts generally pay:
45% on most non-dividend income
39.35% on dividend income
Most trusts also have a small tax-free amount of £500, although this can be divided where the same settlor has created multiple trusts.
This is an important reminder that trusts are not automatically tax-efficient.
A client might use a discretionary trust because they value control and flexibility even though the ongoing Income Tax treatment is less favourable than personal ownership.
The Discretionary Trust Tax Pool
The trust tax pool is easiest to understand as a running record/ ledger of Income Tax already paid by the trustees which has not yet been used to support beneficiary distributions.
Suppose a discretionary trust receives £10,000 of interest.
At a 45% tax rate, the trustees pay:
£10,000 × 45% = £4,500
That leaves:
£5,500 cash after tax.
The trust's tax pool has effectively increased by £4,500.
Importantly, the trustees do not have to distribute the £5,500 immediately. In a discretionary trust, they can retain income within the trust and decide later whether, when and how much to distribute to beneficiaries.
The £4,500 in the tax pool is therefore not money sitting in a separate account. It is simply a tax record showing that the trustees have already paid £4,500 of Income Tax which has not yet been matched against a beneficiary distribution.
If the trustees later distribute £5,500 to a beneficiary, the beneficiary is treated as receiving:
£10,000 gross income
Less £4,500 tax credit
Equals £5,500 cash.
The £4,500 tax credit is then deducted from the tax pool.
If the beneficiary's own tax rate is lower than 45%, they may be able to reclaim some of that tax.
Any unused balance in the tax pool can generally be carried forward into later tax years.
Why the Tax Pool Matters
The tax pool matters because when trustees make an income distribution to a beneficiary, that payment is treated as having already suffered tax at 45%, regardless of whether the trust originally received the money as interest, dividends or another type of income.
This means HMRC does not try to trace each beneficiary payment back to the precise source of the trust's income. Instead, a discretionary trust income payment is given a standard 45% tax credit.
The complication is that not all trust income is actually taxed at 45%. For 2026/27, discretionary trusts generally pay:
45% on most non-dividend income
39.35% on dividend income
For example, suppose the trust receives £10,000 of dividends.
Dividend income: £10,000
Tax at 39.35%: £3,935
Net income remaining: £6,065
The £3,935 of tax is added to the trust's tax pool.
However, if the trustees distribute income to a beneficiary, the payment still has to be treated as a net payment after 45% tax.
For example, if the trustees distribute £5,500, this is treated as:
£10,000 gross trust income
Less:
£4,500 tax credit
Equals:
£5,500 paid to the beneficiary
But the dividend income only generated £3,935 of tax for the tax pool.
If there were no existing tax pool balance, there would therefore be a:
£4,500 − £3,935 = £565 shortfall
The trustees may have to pay additional tax to make good that deficit.
However, the tax pool can contain unused tax credit carried forward from previous years. For example, tax previously paid at 45% on interest that was retained within the trust may still be available in the pool to support a later dividend-funded distribution.
The practical takeaway is:
Trustees pay tax → tax builds up in the pool → beneficiary income distributions use up the pool.
And:
Before making a large discretionary trust income payment, check that the tax pool contains enough tax credit to support the 45% tax credit attached to the distribution.
Capital Gains Tax and Trusts
Capital Gains Tax is best understood by looking at three stages:
Assets entering the trust
Assets being sold inside the trust
Assets leaving the trust
A key point is that CGT can arise even where no cash is received.
Assets Entering the Trust
Suppose John bought an investment portfolio for £100,000.
It is now worth £200,000.
He transfers the portfolio directly into a discretionary trust.
For CGT purposes, HMRC generally treats him as disposing of the investment at its current market value.
His gain is therefore:
£200,000
Less £100,000 original cost
Equals £100,000.
John could therefore face CGT even though he has not sold the investment and has received no cash.
That is an important difference between transferring cash and transferring an appreciated asset.
If John places £200,000 of cash into trust, there is generally no capital gain.
If he transfers investments worth £200,000 that originally cost £100,000, there is potentially a £100,000 gain.
Hold-Over Relief
Hold-over relief allows that gain to be postponed rather than taxed immediately.
Using the same example:
John's original cost: £100,000
Current value: £200,000
Gain: £100,000
Without hold-over relief, John may pay CGT on the £100,000 gain when the investment enters the trust.
With hold-over relief, John does not pay the CGT immediately.
Instead, the trustees effectively inherit the lower historic base cost.
So although they receive an asset worth £200,000, their effective base cost remains around £100,000.
Suppose they later sell it for £250,000.
Their gain would then broadly be:
£250,000
Less £100,000
Equals £150,000.
The original £100,000 gain has not disappeared.
It has simply been carried forward.
The easiest way to remember hold-over relief is:
The gain is delayed, not erased.
This can be particularly valuable where someone makes a gift of an investment into trust and would otherwise face a large CGT bill despite receiving no sale proceeds.
Trustees Selling Investments
The next CGT scenario is simpler.
Suppose trustees buy a fund for £100,000 and later sell it for £150,000.
The trust has made a £50,000 gain.
In a discretionary trust, the trustees are generally responsible for that CGT.
For 2026/27, most trusts have a £1,500 annual exempt amount.
After deducting that allowance and any capital losses, the remaining taxable gain is generally subject to the trustee CGT rate of 24% as of September 2026.
The key point is:
If the trust itself sells an investment, the trustees generally deal with the CGT.
Assets Leaving the Trust
CGT can also arise when trustees transfer an investment directly to a beneficiary.
Suppose the trust owns shares with:
Base cost: £100,000
Current value: £180,000
The trustees transfer those shares directly to Sarah.
Even though Sarah pays nothing for them, the trustees are generally treated as disposing of the shares at market value.
That creates a potential:
£180,000
Less £100,000
Equals £80,000 gain.
Without relief, the trustees could therefore have a CGT liability.
However, hold-over relief may again be available.
If the £80,000 gain is held over, the trustees do not pay CGT immediately.
Sarah effectively receives the shares with the historic £100,000 base cost.
If she later sells them for £200,000, her gain would broadly be:
£200,000
Less £100,000
Equals £100,000.
Again, the gain has been deferred rather than removed.
Bare Trusts and CGT
Bare trusts work differently because the beneficiary is generally treated as the underlying owner.
Suppose £50,000 is invested through a bare trust for a beneficiary.
The investment grows to £80,000 and is sold.
The £30,000 gain will generally be treated as the beneficiary's gain.
That means their own:
Annual exempt amount
Capital losses
CGT rate
will normally be relevant.
This is another example of why identifying the trust type must always come before calculating the tax.
Settlor-Interested Trusts
Another important question is whether the settlor can still benefit from the trust.
If the settlor, or in some cases their spouse or civil partner, can benefit, special Income Tax rules may apply.
The important practical question is simply:
Can the settlor still benefit from the trust?
If the answer is yes, the tax treatment needs closer investigation.
Gifts With Reservation of Benefit
Putting an asset into trust does not automatically remove it from someone's estate for IHT purposes.
Suppose someone transfers their house into trust for their children but continues living in it rent-free.
Although legal ownership has changed, the donor has continued to benefit from the asset.
The gift may therefore be caught by the gift with reservation of benefit rules and still be treated as part of their estate.
The underlying principle is straightforward:
To make an effective gift for IHT purposes, the donor normally needs to genuinely give up the benefit.
Loan Trusts
Loan trusts are useful where the client wants estate planning but is reluctant to permanently give away the original capital.
Instead of making a gift, the settlor lends money to the trustees.
Suppose someone lends £500,000 to a trust. The trustees invest it and the fund grows to £750,000.
The settlor retains a right to repayment of the £500,000 loan, and the outstanding loan remains an asset of their estate. The trustees own the investments themselves.
However, the £250,000 growth belongs to the trust and is generally outside the settlor's estate.
The settlor can usually take partial loan repayments over time, giving them flexibility to draw capital as needed. As those repayments are made and spent, the amount of the outstanding loan remaining in the estate reduces.
The planning objective is therefore broadly:
Retain access to the original capital whilst moving future growth outside the estate.
A loan trust is therefore mainly an estate-freezing strategy rather than an immediate IHT-reduction strategy. That is very different from a straightforward gift trust.
Discounted Gift Trusts
A discounted gift trust is designed for someone who wants to make a gift for estate-planning purposes but still wants to retain a fixed right to future payments.
The crucial point is that the client does not give away the whole investment.
Instead, the arrangement is effectively split into two parts:
The part the client keeps for themselves
The part that is genuinely given away for the beneficiaries
The value of the part the client keeps is what creates the discount.
A Simple Example
Suppose a client invests £500,000 into a discounted gift trust (DGT).
The client gives up access to the £500,000 capital, so it is no longer available to them. However, as part of the DGT arrangement, they retain the right to receive fixed withdrawals for the rest of their life.
An actuarial calculation determines that the current market value of those retained withdrawal rights is £120,000.
You can therefore think of the arrangement as:
£500,000 is transferred into the DGT and the client gives up access to the capital.
However, the client retains valuable rights to future payments, worth £120,000.
Therefore, for IHT purposes, the value actually given away is reduced by the value of those retained rights.
£500,000 invested
Less £120,000 value of retained rights
= £380,000 gift for IHT purposes
The £120,000 is the ‘discount’. It represents the value of the rights the client has retained rather than given away.
So, although £500,000 has been transferred into the arrangement, the client's gift for IHT purposes is only £380,000 because they have retained withdrawal rights worth £120,000.
Importantly, the £120,000 does not mean the client will necessarily receive exactly £120,000 back. It is the actuarial value today of their right to receive the agreed future withdrawals.
What Has the Client Actually Kept?
The client does not retain general access to the trust.
They keep only the specific rights established when the arrangement is created.
For example, they might retain the right to receive:
£20,000 a year
5% of the original investment each year
A series of predetermined capital payments
Those retained payments belong to the client.
The remaining trust assets are held for the beneficiaries.
This is important because a discounted gift trust is not a structure where someone can put £500,000 into trust, claim an IHT benefit and then take back whatever they want later.
Their rights must be clearly defined from the outset. HMRC describes discounted gift arrangements as involving a gift whilst the settlor retains clearly defined rights, often predetermined future capital payments.
Why Is There an Immediate ‘Discount’?
The discount arises because the client's retained payments have a value today.
Imagine someone promises you £20,000 every year whilst they remain alive.
That future income stream is worth something.
An actuary therefore places a present value on the client's retained rights.
The higher that value, the less the client is regarded as having given away.
For example:
Investment: £500,000
Value of retained rights: £150,000
Gift for IHT purposes: £350,000
The client has effectively retained something worth £150,000 and gifted something worth £350,000.
That is why the arrangement is called a discounted gift trust.
What Determines the Size of the Discount?
The discount is not a standard percentage.
It depends heavily on the client's circumstances when the trust is established.
Important factors include:
Age
Health
Insurability
Level of retained withdrawals
Expected duration of those payments
Actuarial and market assumptions
HMRC specifically considers age, health and insurability when valuing the retained rights.
Consider two clients who both invest £500,000 and retain the same annual payment.
A younger, healthy client is statistically more likely to receive those payments for many years.
Their retained rights may therefore be worth more.
That produces a larger discount and a smaller initial gift.
An older client in poor health may be expected to receive fewer future payments.
Their retained rights may therefore have much less value.
That produces a smaller discount and a larger initial gift.
In some cases, where the settlor is effectively uninsurable at outset, HMRC's view is that the retained rights may have only nominal value. The gift could then be close to the full amount invested.
What Happens to the Retained Payments?
Suppose the client has retained the right to £20,000 a year.
Those payments continue according to the original trust terms.
They are not distributions made at the trustees' discretion.
They are rights that belonged to the client from the outset.
The client has never gifted those rights away, which is why their value is deducted when calculating the size of the original gift.
Why Doesn't This Fall Foul of the Gift With Reservation Rules?
Normally, someone cannot give away an asset, continue benefiting from the same asset and still claim that it has left their estate.
That would potentially be a gift with reservation of benefit.
A properly structured discounted gift trust is different.
The settlor carves out and retains specific rights from the beginning.
They then gift the remaining rights.
In other words, they are not saying:
'I give away all £500,000, but I still want to use some of it.'
They are effectively saying:
'I am keeping these specific future payments for myself, and I am giving everything else away.'
Provided those retained rights are sufficiently clearly defined, HMRC accepts that the normal gift with reservation rules need not apply.
The Client Cannot Simply Take More Money Later
This is one of the biggest planning considerations.
Once the arrangement has been established, the settlor generally cannot simply increase their retained rights because they later decide they need more money.
For example, suppose the client retains:
£20,000 a year
They cannot normally decide five years later:
'I actually need £35,000 a year now.'
The amount they retained was defined when the trust was established.
Anything else has genuinely been given away.
That makes affordability extremely important.
Before establishing a discounted gift trust, an adviser therefore needs to consider whether the client has:
Enough capital outside the trust
Sufficient emergency reserves
Adequate income from other sources
Enough flexibility if circumstances change
A realistic level of future expenditure
A client who may need significant access to the original capital later may therefore be better suited to another arrangement.
Discounted Gift Trust Versus Loan Trust
The easiest way to understand a discounted gift trust is to compare it with a loan trust.
With a loan trust, the client broadly retains access to the original amount lent.
For example:
Client lends: £500,000
Trust grows to: £700,000
The £500,000 loan is still repayable to the client.
Only the £200,000 growth has effectively moved outside their estate.
With a discounted gift trust, the client makes an immediate gift but keeps only predetermined future payments.
For example:
Client invests: £500,000
Value of retained rights: £120,000
Initial gift: approximately £380,000
The client cannot later demand the £380,000 back.
The trade-off is therefore broadly:
Loan trust = Greater access, but slower IHT benefit
Discounted gift trust = Less access, but potentially larger immediate estate-planning benefit
What Happens if the Client Dies?
If the settlor dies, their retained rights normally cease.
The remaining trust assets continue to be held for the beneficiaries according to the trust terms.
The client therefore no longer has an economic interest in those future retained payments.
This is another reason the actuarial valuation depends on life expectancy: the value of the retained rights depends on the probability that the settlor will survive long enough to receive them.
Is the Gift a PET or a CLT?
The answer depends on the underlying trust structure.
A discounted gift arrangement can be written using different trust forms.
For example:
A bare or absolute trust may result in a PET
A discretionary trust will generally result in a CLT
So the 'discount' tells us the size of the gift.
The underlying trust tells us how that gift is treated for IHT purposes.
That distinction is important.
For example, if £500,000 is invested and the actuarial discount is £120,000:
Gift = £380,000
If it is structured as a discretionary trust, that £380,000 would generally be considered as the relevant CLT.
The discount does not itself make the transfer exempt from IHT.
It simply reduces the value considered to have been transferred.
The Main Planning Purpose
A discounted gift trust can suit someone who:
Wants to reduce the value of their estate
Is comfortable giving away capital
Still requires a predictable stream of future payments
Does not need unrestricted future access to the money
Wants trustees to control the remaining assets for beneficiaries
Life Assurance Trusts
Life assurance is one of the most common areas where trusts are used in financial planning.
Suppose someone has a £500,000 life policy.
If the proceeds are paid into their estate, the money may form part of the estate and thus be taxable and may also be delayed whilst probate is obtained.
If the policy is appropriately written in trust, the proceeds can normally be paid to the trustees instead.
This can:
Keep the policy proceeds outside the estate
Avoid waiting for probate
Provide money to beneficiaries more quickly
Potentially provide liquidity to help meet an IHT liability
This is a good example of a trust being used primarily for control, succession and practicality.
Split Trusts
A split trust is commonly used with a policy that combines life assurance and critical illness cover. It separates the policy benefits into two categories:
Retained benefits: Benefits payable during the policyholder’s lifetime, such as a critical illness payment, which remain available to the policyholder
Gifted benefits: Benefits payable on death, which are held by the trustees for the chosen beneficiaries
If the policyholder suffers a qualifying critical illness, the retained benefit is normally paid to them. If they die, the life assurance benefit is paid to the trustees, who distribute it to the designated beneficiaries or retain it in accordance with the trust.
The main benefits are:
The policyholder retains access to benefits they may need during their lifetime
The death benefit should normally fall outside their estate for IHT purposes
Trustees can receive the death benefit without waiting for probate
Trustees retain control over how and when beneficiaries receive the money
Because the policyholder retains the living benefits from the outset, rather than gifting them and continuing to benefit from them, a correctly structured split trust should not create a gift with reservation.
Premiums paid after the policy is placed in trust are normally lifetime gifts. They may be covered by the annual exemption or normal expenditure out of surplus income exemption; otherwise, the seven-year rules may need to be considered.
Trust Registration Service
Trust planning also comes with administration.
Many UK trusts need to be registered through HMRC's Trust Registration Service, including many trusts that do not currently have a tax liability.
Trustees also need to keep trust information up to date.
This matters because good trust planning is not just about choosing the correct structure.
The ongoing administration must also be handled properly.
Bringing Everything Together
Trusts become much easier to analyse when each tax is considered separately.
Imagine a client wants to transfer a £500,000 investment portfolio into a discretionary trust.
The first question should not be:
‘How much tax will this save?’
It should be:
‘Why does the client want the trust?’
Perhaps they want trustees to control when their children receive money.
Perhaps they want to protect the capital for future generations.
Perhaps they want flexibility over which family members ultimately benefit.
Once the objective is clear, the tax analysis follows.
For Inheritance Tax:
Is the transfer a CLT?
What previous transfers has the client made?
Is there any immediate lifetime IHT?
Could ten-year or exit charges arise?
For Capital Gains Tax:
What did the client originally pay for the assets?
What unrealised gains exist?
Will transferring the assets trigger a disposal?
Is hold-over relief available?
For Income Tax:
What income will the trust produce?
What rates will apply?
Will income be accumulated or distributed?
What does the tax pool look like?
For the client personally:
Can they afford to lose access to the assets?
Do they genuinely want to give up control?
Who should act as trustee?
Who should eventually benefit?
Is the trust flexible enough for future changes in circumstances?
That is the real planning exercise.
A Simple Framework for Analysing Any Trust
When looking at a trust, work through the following questions.
1. What type of trust is it?
Bare, discretionary, interest in possession or another specialist structure?
2. Who can benefit?
Does a beneficiary have an absolute right, an income right or merely the possibility of receiving something at the trustees' discretion?
3. What happens when assets enter the trust?
Is the transfer a PET or a CLT?
Could CGT arise?
Could hold-over relief apply?
4. How are the assets taxed whilst inside the trust?
Who pays Income Tax?
Who pays CGT?
What allowances are available?
5. What happens when money or assets leave the trust?
Is the payment income or capital?
Could there be an exit charge?
Could an asset transfer create a CGT disposal?
Does the tax pool need to be checked?
6. What has the settlor actually given up?
Do they still have access?
Can they still benefit?
Is there any gift with reservation issue?
Those questions usually reveal the major planning and tax issues.
Trusts Are About Control Before Tax
The most important thing to remember is that trusts are not simply vehicles for reducing tax.
Their real value is often the ability to control:
Who benefits
When they benefit
How much they receive
Who manages the assets
What eventually happens to the wealth
Tax then sits around that structure.
In some situations, a trust may actually create a less favourable tax position than personal ownership.
If the client's objective is to protect assets for children, control the timing of an inheritance, provide for one beneficiary whilst preserving capital for another or give trustees discretion over future distributions, the trust may still be the right structure.
The adviser should first establish what the client wants to happen to the assets. Only then should the most appropriate trust structure and its tax consequences be considered.
The objective is not simply to find the arrangement with the lowest tax bill. It is to find the structure that best achieves the client's objectives whilst understanding and managing the tax consequences that come with it.