How Does Inheritance Tax Apply to Trusts?

# How Does Inheritance Tax Apply to Trusts?

Trusts face three potential Inheritance Tax charges: when assets go in, when they come out, and at ten-year intervals whilst they remain in trust. Understanding these charges is important if you're considering setting up a trust or are already a trustee, as the rates and calculations differ from standard Inheritance Tax rules.

What happens when you put assets into a trust

Putting assets into a trust is known as 'making a settlement' or 'settling property'. For most types of trust, you'll face an Inheritance Tax charge if the total value of transfers (including any other gifts you've made in the previous 7 years) exceeds £325,000.

The rate depends on who pays:

• If the trustees pay the Inheritance Tax, the rate is 20% on the amount above the threshold
• If you as the settlor pay instead, the calculation becomes more complex because your payment increases the loss to your estate, which in turn increases the tax due

The seven-year rule

If you die within 7 years of transferring assets into a trust, your estate must pay Inheritance Tax at the full rate of 40% instead of the 20% paid during your lifetime. Your personal representative (the person managing your estate) will need to pay an additional 20% based on the value of the original transfer.

If no Inheritance Tax was due when you made the transfer, the value still gets added to your estate when calculating whether any Inheritance Tax is due on your death.

Gifts with reservation of benefit

If you transfer an asset to a trust but continue to benefit from it—for example, you give away your house but continue living in it—you'll pay 20% on the transfer and the asset still counts as part of your estate when you die. This creates two possible tax charges, but to avoid double taxation, only the higher charge applies. You'll never pay more than 40% Inheritance Tax in total.

Trusts for disabled people

If you make a gift to a trust for someone who is disabled, you don't have to pay Inheritance Tax immediately, though it may still be due when you die.

Exit charges: when assets leave the trust

An 'exit charge' applies when assets are transferred out of a trust. The maximum rate is 6% of the asset's value. This charge applies to what's known as 'relevant property'—assets such as money, shares, houses or land held within most trusts.

A transfer out of trust occurs when:

• The trust comes to an end
• Assets are distributed to beneficiaries
• A beneficiary becomes 'absolutely entitled' to enjoy an asset
• An asset becomes part of a special trust (such as a charitable trust)
• The trustees enter into a transaction that reduces the trust fund's value

When exit charges don't apply

Even for relevant property trusts, there's no exit charge in certain situations:

• On payments by trustees of costs or expenses incurred on trust assets
• On some capital payments to beneficiaries where Income Tax will be due instead
• When assets are transferred out within 3 months of setting up the trust, or within 3 months following a ten-year anniversary
• When the assets are 'excluded property'

Which assets count as relevant property?

Most property held in trusts counts as relevant property, but there are exceptions. Inheritance Tax charges on transfers and ten-year anniversaries don't apply when the asset is:

• In an interest in possession trust and was put there before 22 March 2006
• Subject to a 'transitional serial interest' made between 22 March 2006 and 5 October 2008
• Put into an interest in possession trust by the terms of a will or the rules of intestacy
• Set aside for a disabled person
• Set aside for a bereaved minor
• Put into an '18 to 25 trust'

Ten-year anniversary charges

Trusts holding relevant property face an Inheritance Tax charge every 10 years. The rate and calculation depend on the trust's specific circumstances and value at the anniversary date.

Excluded property

Some assets are classed as 'excluded property' and don't pay Inheritance Tax, though their value may be used when calculating the rate of tax on exit charges and ten-year anniversary charges.

Excluded property can include:

• Property situated outside the UK owned by trustees and settled by someone who died before 6 April 2025 and was permanently based outside the UK when making the settlement
• Property settled by someone who, on or after 6 April 2025, is not a long-term UK resident when the charge happens or was not a long-term UK resident when they died
• Government securities known as FOTRA (free of tax to residents abroad)

How assets are valued for Inheritance Tax

When calculating whether Inheritance Tax is due on trust charges, you always use the total value of all assets in the trust, even though different assets within the same trust may receive different tax treatment. For example, one asset might be held at the trustees' discretion (treated as a discretionary trust) whilst another is set aside for a disabled person, with different Inheritance Tax rules applying to each.

Calculating exit charges

The calculations for exit charges are complex and require specific information:

• The value (before any Inheritance Tax reliefs) of all assets transferred into the trust, valued at the dates of transfer
• The value of all other transfers into other trusts made by the settlor on the same day the trust was set up
• The value of all chargeable transfers the settlor made in the 7 years before the trust was established

The calculation differs depending on whether the transfer out occurs during the first 10 years of the trust's life or later.

Sources

• Trusts and Inheritance Tax
• Passing on property
• Trusts for vulnerable people
• Types of trust
• Gifts and exemptions

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.