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Trusts Explained — Types, Tax and When to Use One

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Trusts are one of the most powerful tools in estate and financial planning — yet they're also one of the least understood. Used correctly, a trust can protect assets, reduce tax, provide for vulnerable beneficiaries and ensure your wealth passes to the right people at the right time. This guide explains how they work in plain English.

What is a trust?

A trust is a legal arrangement in which one person (the settlor) transfers ownership of assets to a group of people (the trustees), who hold and manage those assets for the benefit of specified people (the beneficiaries). The trust deed sets out the rules governing how assets are managed and distributed.

The key distinction is that once assets are placed into a trust, they no longer legally belong to the settlor. The trustees own them — but they are bound by law to manage them solely in the interests of the beneficiaries.

The three key parties

Role	Who they are	What they do
Settlor	The person creating the trust	Transfers assets into the trust and sets the rules via the trust deed
Trustees	The legal owners of trust assets	Manage and invest assets, make distributions, file tax returns
Beneficiaries	Those who benefit from the trust	Receive income or capital according to the trust deed

The settlor can also be a trustee or beneficiary in some structures, though this has tax implications and should be set up carefully.

Types of trust

Bare trust

The simplest form. The beneficiary has an absolute, immediate right to both the income and the capital. Trustees are merely nominees — they hold the assets in name only. Once the beneficiary reaches 18 (or 16 in Scotland), they can demand the assets outright.

Bare trusts are commonly used to hold investments for children. Income and gains are taxed as if they belong to the beneficiary, not the trustee. If the settlor is a parent and the child is under 18, any income above £100/year is taxed as the parent's income.

Discretionary trust

Trustees have full discretion over who receives income and capital, when, and how much. No beneficiary has a fixed entitlement — the trustees decide at their discretion, guided by the trust deed and a "letter of wishes" from the settlor. This flexibility is the main advantage: circumstances can change and the trustees can adapt.

Discretionary trusts are popular for estate planning because assets are outside the settlor's estate (if they survive 7 years), and trustees can distribute to beneficiaries in lower tax bands to minimise tax overall.

Interest in possession trust (life interest trust)

A named beneficiary has the right to income from the trust for a specified period — often their lifetime. They do not own the underlying capital, which passes to remaindermen (other beneficiaries) when the interest ends. A common use is a surviving spouse who receives income from the family home during their lifetime, with the property ultimately passing to children.

Accumulation trust

Trustees accumulate income within the trust rather than distributing it, adding it to the trust capital. These are often used where beneficiaries are young and not yet ready to receive income.

Mixed trust

Combines elements of the above — for example, an interest in possession for one beneficiary with a discretionary element for others.

Charitable trust

Assets are held for charitable purposes. Charitable trusts receive significant tax advantages — no income tax, no capital gains tax and no inheritance tax on assets within the trust.

How trusts are taxed

Income tax

Trusts have their own income tax rules, separate from individuals:

Trust type	Rate on savings income	Rate on other income
Bare trust	Beneficiary's own rate	Beneficiary's own rate
Interest in possession	20% (basic rate)	20% (basic rate)
Discretionary / accumulation	45% (above £1,000 band)	45% (above £1,000 band)

Discretionary trusts have a £1,000 standard rate band — income up to this amount is taxed at 20% (or 8.75% for dividends). Above £1,000, the rate rises to 45% (39.35% for dividends). When income is distributed to beneficiaries, they receive a tax credit and may reclaim the difference if they are lower-rate taxpayers.

Capital Gains Tax

Trusts are subject to CGT when they dispose of assets. The annual exempt amount for trusts is £1,500 (half the individual allowance of £3,000). The CGT rate for trusts is 24% on most assets. Hold-over relief is available for gifts of business assets into a trust, deferring the gain until the beneficiary later sells.

Inheritance Tax

IHT is the most complex area of trust taxation:

• Entry charge: Transfers into most trusts (other than bare trusts and some interest in possession trusts) are treated as chargeable lifetime transfers. If the value transferred exceeds the settlor's nil-rate band (£325,000), an immediate IHT charge of 20% applies on the excess.
• 10-year anniversary charge: Every 10 years, discretionary trusts face a charge of up to 6% on the value of assets above the nil-rate band.
• Exit charge: When assets leave a discretionary trust (by distribution to a beneficiary), a proportionate exit charge applies — a fraction of the most recent 10-year anniversary charge.

Why use a trust?

• Estate planning: Reduce IHT by moving assets outside your estate whilst providing for your family.
• Protecting vulnerable beneficiaries: Ensure assets are managed for someone who cannot manage them themselves (a child, someone with a disability, or someone with addiction issues).
• Controlling distribution: Prevent a windfall being spent unwisely — trustees can release capital at milestones (reaching 25, getting married, buying a first home).
• Divorce protection: Assets in a discretionary trust are generally outside a beneficiary's personal estate and may be protected in divorce proceedings.
• Business succession: Ensure your business passes smoothly to the next generation or chosen successors.

Trustee responsibilities

Being a trustee is a serious legal responsibility. Trustees must:

• Act in the best interests of beneficiaries at all times
• Invest trust assets prudently (following the Trustee Act 2000 standard of care)
• Keep accurate records and accounts
• Register the trust with HMRC's Trust Registration Service (TRS) — most UK trusts must register
• File annual trust tax returns and pay any tax due
• Not profit personally from their position unless the trust deed expressly permits it

Trustees can be held personally liable for breaching their duties, so many opt for professional trustees — solicitors, accountants or trust companies — particularly for larger or more complex trusts.

Trust Registration Service (TRS)

Since 2022, most UK express trusts must be registered with HMRC's Trust Registration Service, regardless of whether the trust has a UK tax liability. Failure to register can result in penalties. Exceptions include certain charitable trusts, pension scheme trusts and some statutory trusts.

Is a trust right for you?

Trusts are not just for the very wealthy. They can be valuable for anyone who wants to:

• Pass assets to children in a controlled way
• Protect a vulnerable family member's long-term care needs
• Reduce an IHT liability on a growing estate
• Ensure a surviving spouse is provided for while preserving capital for the next generation

However, trusts involve setup costs, ongoing administrative obligations and complex tax rules. They should always be established with professional legal and financial advice.