How Trusts can help families act smartly to pay less inheritance tax
Former Chancellor Roy Jenkins once said “Inheritance Tax is a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”. Could a Discretionary Trust be the answer to this conundrum?
A cornerstone of Inheritance Tax (IHT) planning is lifetime giving, i.e., gifting money or assets away to the next generation(s) and surviving that gift by seven years.
However, as advisers we often hear recurring concerns, particularly when it comes to gifting to children and young adults. Comments like ‘but can we trust them with it?’, ‘what if they go off the rails and squander it?’, ‘what if it reduces their ambition, attracts a bad partner or is one day lost in divorce?’. Practical concerns can also arise about young grandchildren, with comments like ‘they are too young to manage the money’, ‘what if another one comes along?’, or ‘if I give them all shares, they’d just fight’.
An answer to this conundrum might be a Discretionary Trust. Often derided as complex, the concept is ancient and simple – one person (the ‘settlor’) gifts cash or assets to a Trust, and the assets are then managed by ‘trustees’, for the benefit of the ‘beneficiaries’. Beneficiaries can be defined as a class (for example, capturing all descendants of the settlor). Beneficiaries have no control over the assets and no entitlement to Trust income or assets. Whether they receive anything from the Trust is entirely at the discretion of the trustees. It is quite possible for the settlor to also be a trustee, enabling them to retain influence over the Trust assets and distributions.
The Trust can hold a wide variety of investments and can even buy a house for a beneficiary to live in - a useful way of covering the university years, perhaps. Income arising within the Trust suffers tax, but the beneficiaries can get a credit for this. In early adult life, beneficiaries’ own tax allowances are seldom fully used, so trust income distributions can be a tax-efficient way of supporting them through later education.
To prevent up-front IHT charges, cash settled into a Trust is generally limited to £325,000 per person (i.e. £650,000 per couple), each seven years. However, larger values can be settled for shares in an owner-managed trading company due to Business Property Relief (BPR). The current 100% BPR is due to be capped at £1 million from April 2026, so there remains only limited time for family businesses to get the best from the present regime, if looking to use Trusts for business succession purposes.
Example involving family company shares
By way of example, let’s assume that a business owner’s trading company shares are worth £10 million. He is otherwise comfortable financially and content to gift value away, but he is concerned about passing shareholder control to his children/grandchildren and also worries that share division will cause acrimony. He retains the shares and dies 10 years later when the shares are worth £11 million. Following the BPR change in April 2026, the IHT payable on these shares when he dies will be £2 million. In the worst case the company may need to be sold to fund this significant bill.
If the business-owner had instead gifted these shares into a Discretionary Trust before 5 April 2026, there would be no IHT on the initial settlement, nor on his death, because this is over seven years later. With the shares held within the Trust, all share growth and dividend income falls outside his Estate for IHT purposes, and he retains full control of the company as a continuing company Director and as the lead trustee. The Trust’s IHT position is unaffected by his later death, because the Trust instead pays IHT at a lower rate (up to 6%) on every 10 year anniversary of the original settlement. At the first 10 year anniversary, the Trust might face an IHT liability (based on the £11 million value) of just under £300,000. Even this reduced liability can be spread over 10 years, interest free. Funding annual IHT payments of £30,000 per year out of business profits/dividends is far more affordable than finding either £2 million on his death, or £200,000 per year if spread over 10 years.
Use of a trust has swapped very expensive generational IHT for a more affordable regime and has made it more likely that the business can remain within the family. Our article providing more details on the BPR changes can be found here. Further general details on Trust taxation can also be found here.
Whilst a Trust can bring its own complexities and specific advice should always be taken on a case by case basis, a Discretionary Trust remains a very useful tool for families seeking to balance lifetime giving with asset protection.
Please get in touch with Paul Gittins or your usual Crowe contact to discuss further.
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