Understanding Will Trusts and Inheritance Tax

A will trust is a type of trust created in your will, which only comes into effect once you die. It allows you to decide how your trust property, including your home and other assets such as money and shares, is looked after and who benefits from them.

They can play an important role in reducing how much inheritance tax is payable and in protecting family members who may need support over the long term. By setting up the right trust, you can decide how assets are distributed, how income arising is managed, and how beneficiaries are supported for years to come. Will trusts can also be structured to address the changing financial needs of beneficiaries, ensuring flexibility in support and asset distribution.

What are Will Trusts?

A will trust is a type of trust created in your will, which only comes into effect once you die. It allows you to decide how your trust property, including your home and other assets, is looked after, including assets held within the trust, such as money, shares, or real property, and who benefits from it. This can be especially valuable where family members are too young to manage their inheritance, where you want to pass assets down more than one generation, or where you would like to protect wealth from risks such as divorce or creditors.

There are different types of will trusts. A life interest trust, also known as an interest in possession trust, gives one person (known as the life tenant) the right to benefit from both the income and to live in a property during their lifetime. When the life tenant or beneficiary dies, the assets in the trust then pass to others. A discretionary trust is more flexible and gives trustees discretionary powers to decide how and when to distribute trust income or capital among the beneficiaries. In this type of trust, trustees have complete control over both the income and capital, allowing for maximum flexibility. A bare trust, by contrast, is the simplest form of arrangement where assets are held for a named beneficiary, often a child, who will become fully entitled once they reach adulthood, meaning the beneficiary entitled to the trust assets has the right to both the income and capital as soon as they reach the specified age.

These arrangements provide flexibility and asset protection, but they also come with responsibilities. Trustees must act according to the trust deed, manage the settled property carefully, and ensure that any tax payable is reported to HM Revenue & Customs.

Inheritance Tax and Will Trusts

Trusts play an important role in inheritance tax planning because they change the tax treatment of a person’s estate. The inheritance tax charge applied to trust assets depends on the structure chosen and on whether any exemptions or reliefs are available.

Every estate benefits from an inheritance tax threshold, known as the nil rate band. Assets passing to a surviving spouse or civil partner are usually covered by the spouse exemption, meaning no tax is paid at that point. If the surviving spouse later dies, the transferable nil rate band may apply, potentially doubling the available allowance. In other cases, assets transferred during a person’s lifetime may be treated as potentially exempt transfers or chargeable lifetime transfers, depending on the timing of the gift.

Special reliefs are also available for certain business assets and agricultural property. Business property relief and agricultural relief can reduce the amount of inheritance tax due on qualifying assets.

Capital Gains Tax and Income Tax

Inheritance tax is not the only tax to consider. Trustees also need to be aware of capital gains tax and income tax. If trust assets are sold or transferred at a higher market value than when they were acquired, capital gains tax may be payable. There are reliefs that may apply, such as holdover relief, which allows trustees to defer the gain when assets are transferred to a beneficiary.

Income tax is also relevant, as trusts may generate income arising from investments, rent or dividends. Trustees pay tax on this trust income, and the tax rates are often different from those applied to individuals. Understanding the tax pool available and the correct reporting duties for each tax year is vital to ensure compliance with HM Revenue.

Life Interest Trusts

A life interest trust, also known as a possession trust, is often used where a person wants to provide for a spouse or partner while still protecting the capital for children from a previous relationship. The life tenant has the right to receive income from the trust assets or to use property held in the trust, but they do not own the underlying capital. The assets held in the trust may be included in the beneficiary’s estate for inheritance tax purposes, depending on the trust structure. When the life tenant dies, the trust assets pass to the other named beneficiaries.

For inheritance tax purposes, the assets in a life interest trust are treated as part of the life tenant’s estate, which affects the inheritance tax payable. This makes careful planning important to balance the interests of both the current and future beneficiaries.

Exit Charges and Other Tax Considerations

Some trusts, such as discretionary trusts, are subject to what is called the relevant property regime. This can involve inheritance tax charges when assets leave the trust or at periodic reviews. These exit charges and periodic charges depend on factors such as the available nil rate band, whether the trust began as a chargeable transfer, and whether the trust benefits from any special rules.

Bereaved minor trusts and certain trusts for disabled beneficiaries have their own exemptions, which can reduce or remove the inheritance tax charge. Because of the complexity of these rules, trustees often seek professional advice to ensure that tax paid is minimised and that reporting is accurate.

Trustee Duties and Professional Advice

Being a trustee is a serious responsibility. Trustees must act in good faith, keep full records, and always manage the trust fund in line with the trust deed. They must also make sure that both inheritance tax and income tax are reported and paid correctly. If capital gains tax applies, it too must be calculated accurately. Trustees cannot use trust assets for their own benefit and must always act in the best interests of the beneficiaries.

Because the rules around trusts, tax rates, exemptions and reliefs are so complex, professional advice is essential. A solicitor can explain the tax treatment of different trust assets, guide trustees on HM Revenue requirements, and ensure that no unnecessary tax is paid.

Why Choose MJR Solicitors?

At MJR Solicitors, we recognise that estate planning is about more than numbers. It is about making sure that your family members are looked after and that the assets you worked hard to build are protected. We provide clear, straightforward advice on all types of trusts, including discretionary trusts, life interest trusts, bare trusts and special arrangements for vulnerable beneficiaries.

We guide you through every stage, from drafting a trust deed to explaining how much inheritance tax may be payable, to helping trustees pay the right tax on trust income or capital gains. We also help families claim reliefs such as spouse exemption, business property relief and agricultural relief, ensuring that no more tax is paid than necessary.

Our advice is always tailored to your circumstances. Whether you want to pass assets to a surviving spouse, protect business assets for the next generation, or support young beneficiaries until they are ready, we will help you choose the best structure. We also take care of the legal forms and submissions to HM Revenue, giving you peace of mind that everything has been handled correctly.

Summary

Will trusts and inheritance tax are closely linked, and understanding the tax implications is essential for effective estate planning. From discretionary trusts and life interest trusts to bare trusts and potentially exempt transfers, each option has its own inheritance tax treatment, rules on trust income, and possible charges. Trustees must consider not only inheritance tax but also income tax and capital gains tax, as well as exemptions such as the nil rate band, transferable nil rate band and spouse exemption.

Professional advice ensures that all the assets in the trust are managed correctly, that the right tax treatment is applied, and that your beneficiaries receive the full benefit of your estate. With MJR Solicitors, you can be confident that your estate plan is structured to protect your family and preserve wealth for future generations.

Frequently Asked Questions