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Updated on 6 April 2023

Trusts and estates

Trusts are more common than many people realise. They can be used to protect assets or simply hold assets on behalf of another person. Here we look at the different sorts of trusts that might be used and give an overview of how they are taxed. The information that follows is intended purely as a brief outline of the tax rules and not in any way a substitute for proper professional advice. It is also restricted to trusts and beneficiaries resident in the UK.

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Trusts

In its simplest form, a trust is an arrangement where an asset, like a property, is transferred by a person (the settlor) to one or more people (the trustees) to hold for other people (the beneficiaries). The trustees agree to look after the trust assets and, depending on the terms of the trust agreement, will use the assets of the trust for the benefit of the beneficiaries.

You might see trusts like this called ‘express trusts’. This means any kind of trust that has been deliberately created by the settlor. Often – but not always – there will be a trust ‘deed’ or document setting out the terms of the trust, so it usually will be quite clear that a trust exists. If you are in any doubt, then you should seek advice (see below).

It is now necessary for most express trusts to be registered under HMRC’s trust registration service. You can read more about this on our page Trust registration service.

Trust deed

Usually, a trust deed is used to create a trust.

A trust deed is the legal document that sets out:

  • when the trust is established
  • what assets will go into the trust
  • who the trustees are
  • who the beneficiaries are
  • how the beneficiaries can benefit from the trust

How the beneficiaries can benefit from the trust can impact how the trust is taxed.

There does not always have to be a trust deed for a trust to exist. This is particularly true in the case of bare trusts (discussed below), which can be created very informally in some cases, perhaps with just a verbal agreement between parties.

Types of trust

There are three main types of trust, as explained below. However, there are many variations of the different types of trust and how they can be set up. This information is just a brief overview.

Bare trust

This is the most basic type of trust. In this case the beneficiary is entitled to the income and capital of the trust, in the same way as if the asset is owned directly by them outright. In other words, the trustee is just looking after the trust assets on the beneficiary’s behalf. This might be because they are under the age of 18 and cannot legally own certain assets at that age. This is sometimes called a ‘nominee’ arrangement.

Discretionary trust

Where a trust is ‘discretionary’, the settlor will set out a list of potential beneficiaries in the trust deed and will give the trustees power to choose who benefits from the trust income/capital, and when.

Usually, the trustees do not have to pay anything out of the trust each year. For example, they might leave any income within the trust until they decide it is appropriate to pay some to the beneficiaries. This means that the beneficiaries of a discretionary trust have a mere ‘hope’ of receiving funds from the trust rather than an actual right to funds.

Sometimes, the settlor of a discretionary trust will also prepare a ‘letter of wishes’ to go alongside the trust deed. A letter of wishes aims to provide a little more information as to how the settlor would like the trustees to use their discretionary powers. The trustees are not required to follow it.

Interest in possession trust

This is also sometimes called a ‘fixed interest trust’ or ‘life interest trust’. In Scotland, this sort of trust is called a ‘liferent trust’.

In this sort of trust, one or more beneficiaries are entitled to the trust’s income each year. Or perhaps the beneficiary might use the trust assets, for example living in a property owned by the trust. However, the beneficiary is unable to access the capital (trust assets).

The beneficiary receiving the income or using trust property is often called the ‘life tenant’.

Example: Ann

Ann wants to set up a trust for her sister Mary and nieces. Ann is the settlor. Ann can choose the trustees. In the trust deed she needs to make sure she explains precisely how she wants the trust to work and who can benefit from it. For example:

  • Ann could say in the trust deed that the trustees can choose whether or not to pay income or capital to Mary and the nieces, perhaps based on whether they are in need of financial assistance – in which case the trust would be discretionary.
  • Ann could say in the trust deed that the net income in the trust is to be paid to Mary and, following Mary’s death, the trust capital is then paid out equally to the nieces – in which case this would be an interest in possession trustWhen the trust assets are paid out to the nieces following Mary’s death, the trust will come to an end.

Will trust

A will trust is any kind of trust created on a person’s death under their will. This is not a separate type of trust – it could be a bare trust, a discretionary trust, or an interest in possession trust. In the case of a will trust, the deceased person is the settlor.

Often in the case of a will trust, there will not be a separate trust deed – the deceased person’s will sets out the terms of the trust and therefore the trust deed is part of the will itself.

How trusts are taxed

With a bare trust, the beneficiary is treated for tax as if they owned the property themselves. This means they are liable for any tax arising as if they held the property directly. If the bare trust is settled by the parent of a minor child then the parent might be taxable on the income if it is more than £100 (before any tax is taken off) in a tax year.

For most other kinds of trusts, it is the trust itself that is taxable on any income or capital gains that arise. In practice, this means that the trustees are responsible for reporting and paying the trust’s tax liabilities to HMRC. The trustees pay the tax from the funds held in the trust.

However, if the settlor can benefit from the trust, normally any income and gains will be taxed on the settlor.

The inheritance tax position varies depending on the type of trust and how and when it was established. The inheritance tax rules can be complicated.

Below is a basic summary of the tax implications for each sort of trust. Note that for income tax purposes, a trust cannot be a Scottish taxpayer or a Welsh taxpayer, so the rates referred to below are main UK tax rates:

Income tax

Bare trust

Charged to income tax as income of the beneficiary, unless settled by the parent of a minor child and the income is more than £100 a year.

Discretionary trust

The trust has no personal allowance. The first £1,000 of income is taxed at the basic rate.

Any income above this is chargeable to tax at the additional rate.

If trust income is distributed to beneficiaries, the trustees give them a form R185 showing how much tax has been deducted from the income, which the individual can then reclaim if they are chargeable at a lower rate(s).

Interest in possession trust

The trustees give a form R185 to the life tenant showing how much tax has been deducted from the income which the beneficiary has received in the tax year. The beneficiary can then reclaim tax if they pay tax at a lower rate, or may have to pay further tax via self assessment if they pay tax at a higher rate.

Capital gains tax

Bare trust

Charged to capital gains tax as though the asset was owned directly by the beneficiary.

Discretionary trust

The trust has half a CGT annual exempt amount. CGT is then charged at the top rate (20% or 28% depending on the asset).

Interest in possession trust

The trust has half a CGT annual exempt amount. CGT is then charged at the top rate (20% or 28% depending on the asset). Business asset disposal relief may be available in limited circumstances.

Inheritance tax

Bare trust

Charged to inheritance tax as part of the estate of the beneficiary. 

Discretionary trust

Assets entering the trust in excess of the settlor’s IHT nil rate band are charged to IHT at 20% (or at an effective rate of 25% if the settlor pays the IHT).

The trust must then calculate a further charge to IHT every ten-year anniversary of the trust’s creation, and whenever capital is paid out of the trust to a beneficiary. You can read more about these charges on GOV.UK.

The trust assets do not form part of the beneficiary(ies) estate(s) for IHT (unless the trustees pay capital out to the beneficiary – in which case the assets no longer belong to the trust).

Interest in possession trust

In many cases the IHT position for an interest in possession trust will be the same as for a discretionary trust – so a 30% charge on assets entering the trust during the settlor’s lifetime and then ten-year anniversary charges.

However, where an interest in possession trust is established on death (for example under a will) then the assets of the trust will usually form part of the estate of the beneficiary (the life tenant) – even though they are only receiving the income and are not able to access the capital. No ten-year anniversary charges will arise where the assets are treated as forming part of the beneficiary’s estate.

Different rules apply to interest in possession trusts established prior to March 2006.

There are special tax rules that can apply to trusts for certain vulnerable people, including certain people with disabilities. You can read more about these trusts on our page Trusts for disabled people.

Getting help

Trusts can be a complex area of law and tax. We recommend you get competent professional advice when setting up or administering a trust. Such advice might be taken from a:

Estates

When someone dies, their personal representatives must carry out the administration of the estate. This includes dealing with the tax position of the deceased for the year of death and their own position as personal representatives until they have completed the administration of the estate.

The personal representatives must gather in the estate assets, pay liabilities and distribute the estate. The period during which they carry this out is the administration period.

How an estate is taxed

The personal representatives will have to use funds from the estate to pay any tax liabilities that arose in the tax year of death, from the start of the tax year to the date of death.

In addition, as the administration period may last months or even years, the personal representatives may have to pay various taxes in their capacity as personal representatives of the estate, from the date of death to the date when the administration period ends.

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