Do I Pay Inheritance Tax on Money Left in a Trust

Trusts are widely used to protect wealth, safeguard children or vulnerable adults, manage family money and control how assets pass between generations. However many people are unsure how Inheritance Tax interacts with trusts. Some believe trusts eliminate tax entirely while others assume everything inside a trust is taxed twice. The truth sits somewhere in the middle. Some trusts are subject to special Inheritance Tax charges, some are exempt in certain situations and some are only taxed when money leaves the trust.

This article explains the rules in plain language so you can understand what applies to you.

Understanding How Trusts Are Taxed for Inheritance Tax

To know whether you pay Inheritance Tax on money left in a trust, you must first understand one key idea:

Trusts are not all taxed in the same way.
Different trusts fall under different tax systems.

The main categories are:

• Bare trusts

• Interest in possession trusts

• Discretionary trusts

• Settlor interested trusts

• Disabled person’s trusts

• Trusts created on death

• Trusts created during lifetime

Each one has its own Inheritance Tax rules. In my opinion this is why so many people feel confused until the structure is explained properly.

1. Bare Trusts: Inheritance Tax Belongs to the Beneficiary

A bare trust is the simplest type of trust. Money belongs to the beneficiary outright, and the trustee simply manages it until the beneficiary is old enough to take control.

Do you pay Inheritance Tax on money in a bare trust

No, because the money legally belongs to the beneficiary. The value of the trust sits within the beneficiary’s estate, not the trustee’s or the person who set it up.

When tax may be due

Inheritance Tax may apply only when the beneficiary dies, because the funds form part of their estate.

In my opinion

Bare trusts are extremely tax efficient for children or young adults because there are no special trust charges.

2. Interest in Possession Trusts: Income Belongs to the Beneficiary

These trusts give someone the right to income from the trust (the “life tenant”) while the capital is preserved for someone else later.

Do you pay Inheritance Tax on money inside this trust

It depends.

If the trust was created under a will for a surviving spouse or civil partner, it is usually exempt from Inheritance Tax on creation.

However if it was created during someone’s lifetime, or created for someone other than a spouse, certain charges may apply.

Inheritance Tax events include

• When the person who created the trust dies

• If the trust ends and assets pass to the next beneficiaries

• If the life tenant dies

In my opinion

These trusts can be powerful for protecting a spouse after your death while still guaranteeing assets go to your children, but you must understand the potential IHT triggers.

3. Discretionary Trusts: The Most Common Area People Pay Inheritance Tax

A discretionary trust is the one most people worry about because it can trigger Inheritance Tax at several stages. The trustees decide who receives money and when.

Do you pay Inheritance Tax on money in a discretionary trust

Sometimes. These trusts fall under the “relevant property regime” which includes three potential IHT charges:

A. Entry charge

When the trust is created during someone’s lifetime, any amount gifted to the trust above the nil rate band (currently £325,000) may be taxed at 20 percent.

B. Ten-yearly charge

Every ten years, the trust may pay up to 6 percent Inheritance Tax on the value of the assets inside it.

C. Exit charge

When money leaves the trust, an exit charge may apply. This is often small if the ten-yearly charge has already been paid.

Do beneficiaries pay Inheritance Tax when receiving money

No. The trust pays the tax, not the individual beneficiary.

In my opinion

Discretionary trusts offer strong control but come with more admin and more tax rules. People choose these trusts when control is more important than tax simplicity.

4. Trusts Created on Death (Will Trusts)

If a trust is created through a will:

• It may be exempt if the beneficiary is a spouse or civil partner

• It may be taxed under the relevant property regime if it is discretionary

• It may avoid entry charges because it is created at death rather than during lifetime

Do you pay IHT on money left in a will trust

The estate may pay Inheritance Tax before assets enter the trust. After that, ongoing charges depend on the trust type.

5. Settlor Interested Trusts: Special Rules Apply

A settlor interested trust is one where the person who created the trust can benefit from it.

How IHT works

These trusts are treated as if the settlor still owns the assets.

This means:

• The trust assets remain part of the settlor’s estate for Inheritance Tax

• No lifetime entry benefits apply

• Ongoing charges may depend on the structure

In my opinion

These trusts must be set up with extreme care because people often misunderstand the tax implications.

6. Disabled Person’s Trusts: Favourable Rules

Disabled person’s trusts are treated differently.

IHT position

They do not follow the normal discretionary trust regime. They avoid the ten-yearly charge and exit charges.

This makes them tax efficient for vulnerable beneficiaries.

7. Do Beneficiaries Pay Inheritance Tax When They Receive Money From a Trust

In almost all cases, no, the beneficiary does not personally pay Inheritance Tax when they receive money from a trust. If tax is due, the trust pays it before distribution.

The only time the beneficiary pays is when:

• The trust assets form part of their personal estate

• They die while holding a bare trust interest

• They hold an interest in possession trust which counts as part of their estate

8. When Does Inheritance Tax Apply to Money in a Trust

Here is a simple checklist:

You may pay IHT if

• You place more than £325,000 into a discretionary trust during your lifetime

• A discretionary trust hits its ten-year anniversary

• Money leaves a discretionary trust

• The settlor dies and the trust is treated as part of their estate

• A life tenant of an interest in possession trust dies

You do not usually pay IHT if

• The trust is a bare trust

• The trust was created for a spouse

• The trust was created for a disabled person

• The trust is within the nil rate band

• The assets are exempt (for example spouse exemptions or business property relief)

9. How Business and Agricultural Relief Change Trust Tax Outcomes

Some assets qualify for:

• Business Property Relief

• Agricultural Property Relief

If these reliefs apply at 100 percent, the asset can enter a trust with no Inheritance Tax.

In my opinion this is one of the most powerful uses of trusts for business owners who want to protect family assets.

10. The Importance of Trust Registration (TRS)

Most trusts must be registered on the Trust Registration Service.

If a trust is not registered correctly:

• penalties may apply

• beneficiaries may struggle to take funds

• tax planning benefits may be lost

Trust reporting requirements also vary depending on the trust type.

11. Real World Examples

Example 1: Money in a discretionary trust

A grandmother places £500,000 into a discretionary trust.
£325,000 is tax free, and the remaining £175,000 is taxed at 20 percent.
Ten years later the trust pays a small periodic charge.
Beneficiaries receive distributions tax free at the income level.

Example 2: Bare trust for a child

A parent saves £50,000 for their child in a bare trust.
No Inheritance Tax charges apply.
The money belongs to the child outright.

Example 3: Interest in possession trust for a spouse

A husband leaves a right to income to his wife on death.
No Inheritance Tax occurs because it is spouse exempt.
When the wife dies the asset moves to children and becomes taxable.

Example 4: Settlor interested trust

A person sets up a trust but still benefits from it.
HMRC treats the trust as their own estate for IHT purposes.

In My Opinion: Why You Should Get Advice Early

Understanding whether a trust is subject to Inheritance Tax is not straightforward. Trust tax rules are some of the most complex in the UK tax system. In my opinion the biggest mistakes people make are:

• assuming trusts eliminate all tax

• assuming all trusts are treated the same

• forgetting about ten-year charges

• thinking beneficiaries will pay tax personally

• misunderstanding the IHT effect of gifts into trusts

A short conversation with an accountant or trust specialist can prevent costly errors.

Conclusion

Whether you pay Inheritance Tax on money in a trust depends entirely on the type of trust, how it was created and who benefits from it. Bare trusts tend to be tax free for beneficiaries, interest in possession trusts may be taxed on the death of the life tenant and discretionary trusts are subject to the relevant property regime which includes entry, ten-yearly and exit charges.

In my opinion the key is to understand the trust structure early and plan ahead. Trusts can be incredibly effective tools for estate planning, but only when used with the right tax knowledge and advice.