How trusts are taxed

A trust is a legal arrangement in which one person, called the settlor (or "truster" in Scotland), gives cash, property or other assets to trustees to look after on behalf of beneficiaries¹. The trustees legally own the assets, but they must use them for the beneficiaries under the terms of the trust, not for themselves. Trusts are used for many purposes: passing on money to children too young to manage it, providing for a disabled family member, or paying out a life insurance policy quickly on death².

The tax side is where most people get caught out. A trust is treated as its own taxpayer in many situations, with its own rates, its own small allowances and its own inheritance tax regime that can charge up to 20% when assets go in, up to 6% every ten years while they sit there, and an exit charge when they come out³. At the same time, some trusts, such as bare trusts, are barely taxed separately at all, because the beneficiary is treated as the owner¹.

What a trust is and who is involved

Every trust has three roles. The settlor is the person whose assets go into the trust. The trustees are the people who hold and manage those assets. The beneficiaries are the people the assets are held for. In Scotland the person creating the trust is known as the truster rather than the settlor¹.

Trustees can be family members or friends, or professionals such as solicitors or accountants, who will charge for their services². Who you appoint matters: in a discretionary trust the trustees hold real power over who gets what and when, so the choice of trustee shapes how the trust works in practice⁶.

A trust can be created during your lifetime (a lifetime trust) or written into your will, in which case it only comes into being on your death. A will trust is created within your will to let you protect property or assets you hope to pass on to your family⁷. Trusts are also commonly used with life insurance: a trust is essentially a legal arrangement whereby the trust takes ownership of certain assets, including any outstanding debts, so a payout can go straight to the people you chose without waiting for probate⁸.

Each type of trust is taxed differently

There is no single "trust tax". The treatment follows the type of trust, and the differences are large.

• Bare trusts: the beneficiary is treated as the owner of the assets for tax purposes, so income and gains are taxed on them, at their own rates and allowances¹.
• Life-interest trusts: income tax is based on the beneficiary's own tax rate and allowances, rather than the trust being taxed as a separate entity¹.
• Discretionary trusts: the trustees hold a pool of potential beneficiaries and decide who receives what⁷. These trusts fall under the "relevant property" tax regime, which brings the harshest rates: 45% income tax on interest or rental income over £500, the 24% trustees' CGT rate, and the periodic inheritance tax charges covered below¹.
• Vulnerable persons trusts: trusts for a disabled or vulnerable beneficiary receive special tax treatment from HMRC, which depends on the beneficiary's own tax position, and they are not subject to the ten-year inheritance tax charge¹.
• Will trusts: created on death, and generally still considered part of the deceased's estate for inheritance tax purposes¹.

One comparison worth making early: a discretionary trust will most likely pay more tax than a disabled person's trust set up for the same beneficiary, which is why families providing for a disabled child are usually steered towards the latter⁶.

Income tax on trust income, and the £500 tax-free band

Trusts that fall under the relevant property regime, which includes most discretionary trusts, normally pay tax on any income earned over £500¹. That £500 is the trust's only meaningful tax-free band, and it is far smaller than what an individual gets. For comparison, an individual higher-rate taxpayer can receive £500 of savings interest alone tax-free under the Personal Savings Allowance, on top of their personal allowance⁹, and individuals only pay the additional rate of income tax on taxable income over £125,140¹⁰.

Discretionary trusts currently pay income tax at 45% on all interest or rental income if the total is over £500¹. So a trust holding a rental property or a large deposit can face a much higher effective tax rate on its income than the individual beneficiary ever would.

Trustees can deduct some costs before that tax is worked out, but only narrowly. HMRC's guidance states that only trustee expenses that relate directly to trust income are allowed as trust management expenses, such as preparing a tax return for income received, deciding which beneficiaries to pay and how much, and paying income to beneficiaries¹¹. General investment advice or other costs do not qualify.

Where income is actually paid to a beneficiary, the tax treatment depends on the trust. In a life-interest trust, income tax follows the beneficiary's own rate and allowances¹. Income you receive from a trust, settlement or a deceased person's estate is reported on the SA107 pages of a Self Assessment return¹². The basics of how income tax bands work are covered in income tax: bands, rates and how your bill is worked out.

Capital gains tax: trustees pay 24%

When trustees sell or dispose of an asset that has gone up in value, they pay Capital Gains Tax at 24%¹. This rate was set in legislation for gains accruing to trustees that are not residential property gains or carried interest gains, for disposals on or after 30 October 2024⁴. Individuals, by contrast, can be taxed at 18% or 24% depending on their income¹, so a basic-rate beneficiary could face a lower CGT bill on the same gain than the trustees would.

The position is different again for bare trusts. Taking assets out of a bare trust does not trigger a CGT bill, because the beneficiary is treated as owning them outright throughout¹. The gain is simply the beneficiary's gain, taxed at their own rates with their own annual exempt amount.

Trustees must report gains through the trust's own tax return arrangements. HMRC's guidance on trusts and Capital Gains Tax sets out when trustees must report, including where trustees want to claim an allowable loss or make any other claim or election¹³. Where a trust holds a foreign life insurance policy, the gain is reported in the Trust and Estate Foreign Tax Return (SA904), under "Gains on foreign life insurance policies, life annuities and capital redemption policies"¹⁴. How individuals report and pay CGT on their own disposals is covered in how to report and pay Capital Gains Tax.

Inheritance tax on trusts: up to 20% going in, up to 6% every ten years

The relevant property regime imposes three potential inheritance tax charges on a discretionary trust.

Going in. Inheritance tax is normally paid at 20% when setting up a trust, on value in excess of the nil-rate band³. Everyone has a tax-free inheritance allowance worth £325,000, known as the nil-rate band⁵, and in some cases you may pay inheritance tax of up to 20% when assets placed in certain trusts exceed it⁵. One worked example from consumer guidance: transferring £500,000 into a trust would give £43,750 of inheritance tax due, an effective 25% grossed-up rate, if the settlor rather than the trust pays the tax³.

Every ten years. An inheritance tax charge is due on every ten-year anniversary if the value of the trust is greater than £325,000, and this can be up to 6% of the value of the trust assets¹. The 6% is levied on the value of the total assets, less the £325,000 allowance³. In practice the effective rate is usually lower: in one worked example of a trust valued at £750,000 at its ten-year anniversary, the effective rate of tax was 3.399% and the tax payable was £25,492.50³.

Coming out. Transferring assets out of the trust may trigger an exit charge¹. The size of the exit charge depends on how long since the last ten-year anniversary: in the same worked example, a £50,000 distribution five years after the tenth anniversary produced an exit charge of £849.75, worked out as £50,000 multiplied by 20/40 (the fraction of quarters elapsed) and then by the 3.399% effective rate³. HMRC provides a calculator for working out the number of quarters when inheritance tax is charged on a trust for certain chargeable events, which needs the date the assets became relevant property, the trust's start date, the ten-year anniversary date and the date capital is distributed¹⁵. The tax may be reduced when an asset has not been held in the trust for a full ten-year period¹⁵.

The trustees must pay and report exit charge tax by the end of the sixth month after the exit event³. The wider rules on inheritance tax thresholds, rates and who pays are covered separately.

Putting assets in trust does not remove them from inheritance tax straight away

A common misconception is that assets placed in trust are simply exempt from inheritance tax. They are not, and trusts are complicated enough that this mistake can be expensive⁵. For inheritance tax purposes, the act of placing assets into a trust is treated in the same way as making a gift¹⁶. If you die within seven years of placing assets in trust, the assets may be subject to inheritance tax; if you live longer, they fall out of your estate¹.

Where a gift into trust exceeds the £325,000 allowance and the settlor dies within seven years, taper relief reduces the tax the longer the gift was made before death: 40% applies for gifts made zero to three years before death, 24% for four to five years, 16% for five to six years, and 8% for six to seven years¹⁷. The legislation behind this sets the percentage for a transfer made more than six but not more than seven years before death at 20 per cent of the full rate¹⁸. The seven-year rule is explained in gifts and inheritance tax.

Assets placed into a will trust are generally still considered part of your estate for inheritance tax purposes¹. Two exceptions worth knowing:

• Pensions: pension assets are currently generally exempt from inheritance tax¹⁹.
• Life insurance written in trust: if a policy is written into trust, the insurance payout is handled separately from your estate, and so will not be subject to inheritance tax if your estate is valued above the tax threshold⁶.

Note also that assets placed into a discretionary will trust will not be exempt from inheritance tax even if your spouse is one of the beneficiaries¹, which differs from the usual unlimited spouse exemption on outright gifts. The rules for couples are covered in inheritance tax for married couples and civil partners.

Discretionary or bare trust: how tax and access differ

These are the two trusts people most often choose between, and they sit at opposite ends of the spectrum of control and tax.

In a bare trust, the beneficiary has an absolute right to the assets, and is treated as their owner for tax purposes¹. Income and gains are taxed on the beneficiary at their own rates. Taking assets out does not trigger a CGT bill, because the beneficiary is treated as owning them outright¹.

In a discretionary trust, the trustees have a pool of potential beneficiaries and the discretion to benefit any of them⁷. A discretionary trust gives the trustee greater power to decide how much the beneficiaries get and how frequently they get it, plus any conditions the settlor sets⁶. That flexibility has a price: 45% income tax on interest or rent over £500, the 24% trustees' CGT rate, the 20% entry charge, the ten-yearly charge and exit charges¹.

One point of detail on property: for the higher rates of stamp duty land tax on additional dwellings, the beneficiary of a settlement or bare trust, rather than the trustee, is treated as the purchaser where the beneficiary is entitled to occupy the dwelling for life or to income from it²⁰.

For families providing for a disabled person, a discretionary trust can be a stepping stone: it is flexible and can be changed to a disabled person's trust if needed²¹. A discretionary trust set up correctly, where the disabled child is the only principal beneficiary, will not affect their means-tested benefits²¹.

Registering a trust and filing a tax return

Most trusts now have to be registered with HMRC through the Trust Registration Service (TRS). The TRS was first set up in 2017, when it only required trustees to register if the trust incurred income tax, CGT, inheritance tax or other UK tax liabilities; the requirement has since widened³. Will trusts need to be registered with HMRC if they still exist two years after the death of the settlor¹, and a will trust can remain unregistered for up to two years, but if it still exists once those two years are up, it must be registered³.

Trustees also face reporting obligations of their own:

1. Register the trust with the Trust Registration Service. HMRC's guidance on inheritance tax forms tells you to check whether the trust needs registering before you start an IHT100²².
2. Report chargeable transfers. Fill in form IHT100a to tell HMRC about a gift where inheritance tax is payable immediately, including gifts or other transfers of value into a trust²².
3. File trust tax returns. Being a trustee of a registered pension scheme or other trust is one of the circumstances in which a person must complete a Self Assessment tax return²³. Income received from a trust, settlement or deceased person's estate goes on the SA107 pages¹².
4. Report gains. Trust gains, including gains on foreign life insurance policies, go on the trust's own return pages, such as the SA904¹⁴.

If a beneficiary's inheritance is put into a trust and the trust does not or cannot pay the tax due, the liability can fall on the beneficiary²⁴. The deadlines and penalties for filing are covered in Self Assessment: who must file a return and the deadlines.

Where a trust will not help: care fees and means-tested benefits

Trusts are sometimes sold as a way to shield assets, and here the claims often outrun the reality.

Care fees. Trusts will not protect your home from care home fees⁵. Putting assets into a lifetime trust is treated as making a gift, and gifts are permanent, with no going back; deliberate deprivation of assets to avoid care costs can still be challenged¹⁶. One provider of will trusts states that where a home is part-owned by a will trust, the part owned by the trust is not counted, and in this way, currently, it is protected from care home costs⁷. These two positions sit in tension, and the outcome depends on the specific trust, the local authority's assessment and the timing, which is a strong reason to take legal advice rather than rely on a general claim.

Means-tested benefits. The position is more favourable for disabled beneficiaries. Money in a disabled person's trust does not count towards income or savings limits for means testing⁶, and both disabled person's trusts and discretionary trusts can stop money and property counting in means testing for benefits or social care, including supported living⁶. A discretionary trust set up correctly, where the child is the only principal beneficiary, will not affect their means-tested benefits²¹. But the structure matters: if trustees give money directly to the disabled person, it counts towards their income and savings and could affect means-tested benefits or social care⁶.

Not everything is means-tested in the first place. Carer's Allowance is not means-tested, so savings and a partner's income are not relevant²⁵. In Northern Ireland, the mobility component of Disability Living Allowance is also disregarded when the local Trust calculates how much a person should contribute towards the cost of their care²⁶. The wider picture is in benefits in the UK: a complete guide.

Getting help setting up a trust

Trusts are not something to set up from a template. The rules relating to disabled person's trusts and taxation are complicated, so if you are considering one, talk to a solicitor first². You will have to pay for legal advice⁶, and the tax at stake, up to 20% going in and 6% every ten years, usually dwarfs the fee.

A warning on who you buy from: will writing and estate planning are unregulated, so if you write assets into a trust with an unregulated firm, you could be left with little recourse if the trust is poorly drafted¹. Trusts themselves are not regulated by the Financial Conduct Authority, which regulates financial services firms and financial markets in the UK²⁷. Solicitors, by contrast, are regulated by their own professional body, which gives you a route to complain.

One protection worth knowing about if a trust holds deposits: where a trust account is held with a failed provider, the FSCS may "look through" the account holder of a bare trust, and each eligible beneficiary may be treated separately; for non-bare trusts, trustees have a separate claim for each separate trust that they are a trustee of²⁸. Pension trustees are an exception to the general trust rules and are treated differently depending on the type of pension²⁸.

Free, impartial help is available from MoneyHelper on benefits questions²⁵, and charities such as Sense, Scope and Mencap publish guidance specifically on wills and trusts for disabled family members². For the tax mechanics, HMRC's own guidance on trusts and income tax and trusts and Capital Gains Tax is the reference point¹¹.