Do I Pay Inheritance Tax on Money Left in a Trust

At Towerstone, we provide specialist Inheritance Tax accountancy services for families and executors. We have written this article to explain how trusts are treated for Inheritance Tax, helping you make informed decisions.

This is one of the most common and most misunderstood questions I am asked as a chartered accountant. In my experience, trusts are often talked about as if they automatically avoid inheritance tax, and that assumption causes more problems than almost anything else in estate planning.

The honest answer is that yes, inheritance tax can apply to money left in a trust, but how and when it applies depends entirely on the type of trust, when it was created, how it is funded, and what happens to the money afterwards. In my opinion, trusts are neither good nor bad for inheritance tax. They are simply tools, and like any tool, they can be used well or badly.

In this article, I am going to explain how inheritance tax applies to money in trusts in the UK. I will cover the different types of trust, the key tax charges, common misconceptions, and the situations where trusts genuinely help with inheritance tax planning. I will also share practical insight from experience, because this is an area where theory and real life often diverge.

By the end, you should have a clear understanding of whether inheritance tax applies to money left in a trust, and why getting the structure right matters far more than the trust itself.

What Does It Mean to Leave Money in a Trust?

Before looking at the tax position, it is important to be clear on what it means to leave money in a trust.

A trust is a legal arrangement where assets are held by trustees for the benefit of one or more beneficiaries. The trustees control the assets and must follow the rules set out in the trust deed or will.

Money can be placed into a trust in two main ways:

• During your lifetime, known as a lifetime trust

• On death through your will, known as a will trust

From experience, confusion often arises because people do not distinguish between these two situations. The inheritance tax treatment can be very different.

Who Sets the Inheritance Tax Rules for Trusts?

Inheritance tax on trusts is governed by UK tax law and administered by HM Revenue & Customs. The official guidance is published on GOV.UK, but in my opinion it is written for professionals rather than the general public.

Trust taxation is one of the most technical areas of the UK tax system. From experience, even experienced professionals double check the rules regularly because small details can change outcomes significantly.

Does Inheritance Tax Automatically Apply to Trusts?

No, inheritance tax does not automatically apply just because money is in a trust.

This is the first myth that needs clearing up.

Whether inheritance tax applies depends on:

• The type of trust

• When the trust was created

• How the trust was funded

• The value of assets involved

• What happens to the trust over time

In my opinion, asking whether trusts pay inheritance tax is like asking whether companies pay tax. The answer depends on structure and circumstances.

The Main Types of Trust and Their Inheritance Tax Treatment

To understand whether inheritance tax applies, you need to understand the type of trust involved. The UK tax system treats different trusts in very different ways.

The main categories are:

• Bare trusts

• Interest in possession trusts

• Discretionary trusts

• Accumulation trusts

Each has its own inheritance tax rules.

Bare Trusts and Inheritance Tax

A bare trust is the simplest form of trust.

In a bare trust:

• The beneficiary has an absolute right to the money

• The trustees simply hold the money on their behalf

• For tax purposes, the money is treated as belonging to the beneficiary

From an inheritance tax perspective, money in a bare trust is not really separate from the beneficiary.

If you leave money in a bare trust for someone:

• The value is treated as a gift to that person

• If the trust is created during your lifetime, the seven year rule applies

• If the trust is created on death, it is treated as part of your estate

From experience, bare trusts are rarely used for inheritance tax planning because they offer no tax advantage.

Interest in Possession Trusts Explained

An interest in possession trust gives one person the right to income or use of assets, while another person ultimately receives the capital.

A common example is where a spouse receives income for life, and children inherit later.

Inheritance tax treatment depends on when the trust was created.

Trusts Created Before 22 March 2006

Older interest in possession trusts often receive favourable inheritance tax treatment.

In many cases:

• Assets are treated as part of the life tenant’s estate

• No ten year charges apply

• Tax is deferred rather than avoided

From experience, these older trusts are now relatively rare, but they can still exist.

Trusts Created After 22 March 2006

Most newer interest in possession trusts fall within the relevant property regime, which I will explain shortly.

This means inheritance tax can apply during the life of the trust.

Discretionary Trusts and Inheritance Tax

Discretionary trusts are the most commonly discussed trusts in inheritance tax planning.

In a discretionary trust:

• No beneficiary has an automatic right to the money

• Trustees decide who benefits and when

• The trust offers flexibility and control

From an inheritance tax perspective, discretionary trusts fall within the relevant property regime.

This is where many people get caught out.

The Relevant Property Regime Explained

The relevant property regime is the inheritance tax system that applies to most discretionary trusts and many interest in possession trusts.

Under this regime, inheritance tax can apply at three main points:

• When money is put into the trust

• On each ten year anniversary

• When money leaves the trust

From experience, it is these ongoing charges that surprise people the most.

Inheritance Tax When Money Enters a Trust

If you put money into a trust during your lifetime, this is known as a lifetime transfer.

For discretionary trusts, this is usually a chargeable lifetime transfer.

This means:

• The value is added to your previous chargeable transfers

• If the total exceeds the nil rate band, inheritance tax may be due immediately

• The current nil rate band is £325,000

If inheritance tax is due at this stage, it is usually charged at 20 percent.

From experience, people often assume there is no tax until death. That is not always true with trusts.

The Seven Year Rule and Trusts

The seven year rule still matters for trusts.

If you create a lifetime trust and survive seven years:

• The transfer may fall outside your estate

• Additional tax on death may be avoided

However, this does not remove ten year charges or exit charges.

In my opinion, the seven year rule is often misunderstood when applied to trusts.

Ten Year Anniversary Charges

One of the defining features of the relevant property regime is the ten year charge.

Every ten years, the trust is assessed for inheritance tax.

The charge is calculated based on:

• The value of the trust assets

• The available nil rate band

• Previous transfers

The maximum rate is 6 percent.

From experience, this is often described as a small charge, but on large trusts it can be significant.

Exit Charges When Money Leaves a Trust

When money is distributed from a discretionary trust, an exit charge may apply.

This is calculated based on:

• The time since the last ten year charge

• The value leaving the trust

• The effective rate of tax

From experience, exit charges are often overlooked entirely in planning discussions.

Inheritance Tax on Trusts Created by a Will

If a trust is created on death through a will, the position is different.

The assets placed into the trust are part of the deceased’s estate for inheritance tax purposes.

This means:

• Inheritance tax is assessed at death

• Nil rate bands and exemptions apply

• The trust itself does not avoid inheritance tax at this stage

In my opinion, this is one of the biggest misconceptions. A will trust does not automatically save inheritance tax.

Spouse and Charity Exemptions

Trusts can still benefit from inheritance tax exemptions.

If money passes into a trust for the benefit of:

• A spouse or civil partner

• A qualifying charity

Inheritance tax may be reduced or eliminated at death.

From experience, spouse exemption is often used in life interest trusts.

Does Leaving Money in Trust Reduce Inheritance Tax?

Sometimes yes, sometimes no.

From experience, trusts reduce inheritance tax when they are used to:

• Remove future growth from an estate

• Control the timing of gifts

• Protect assets while allowing gradual distribution

Trusts do not reduce inheritance tax simply by existing.

In my opinion, trusts work best when they are part of a long term plan rather than a last minute decision.

Common Myths About Trusts and Inheritance Tax

Over the years, I have heard many myths, including:

• Trusts are inheritance tax free

• Trusts hide money from HMRC

• Trusts always avoid care fees

• Trusts eliminate probate tax

In my opinion, these myths are often promoted by aggressive marketing rather than sound advice.

Trust Income and Capital Gains Tax

Inheritance tax is not the only tax to consider.

Trusts may also pay:

• Income tax at higher rates

• Capital gains tax with reduced allowances

From experience, people often focus on inheritance tax and forget these ongoing costs.

The Role of Trustees in Managing Tax

Trustees have legal duties to manage tax properly.

They must:

• File trust tax returns

• Pay tax on time

• Keep accurate records

• Take professional advice where needed

From experience, being a trustee is a serious responsibility, not an honorary role.

When Trusts Are Usually a Good Idea

In my opinion, trusts tend to work best when:

• There are vulnerable beneficiaries

• There are complex family situations

• Control matters more than tax savings

• Planning is done early

Inheritance tax savings are often a by product rather than the main goal.

When Trusts Are Often a Bad Idea

From experience, trusts are often unsuitable when:

• The only goal is tax avoidance

• The sums involved are modest

• Simplicity is a priority

• The trust is created late in life

In these cases, the costs can outweigh the benefits.

Alternatives to Using Trusts

Trusts are not the only option.

From experience, alternatives may include:

• Lifetime gifting strategies

• Pension based planning

• Insurance solutions

• Well drafted wills

In my opinion, these options are often more effective and easier to manage.

The Importance of Professional Advice

Trust and inheritance tax planning sits at the intersection of tax law, estate planning, and family dynamics.

From experience, problems arise when advice is taken from:

• Unregulated providers

• Generic templates

• Sales driven firms

In my opinion, proper advice always costs less than fixing mistakes later.

So, Do I Pay Inheritance Tax on Money Left in a Trust?

The honest answer is that you might.

Inheritance tax can apply:

• When money enters a trust

• When the trust reaches ten year anniversaries

• When money leaves the trust

• When the trust is created on death

Whether it does depends on structure, timing, and value.

From experience, trusts are powerful but complex. They do not remove inheritance tax by default, but when used properly, they can help manage it in a controlled and sensible way.

Key Takeaways

In my opinion, the biggest mistake people make with trusts is assuming they are a tax shortcut. They are not.

Trusts are about control, protection, and long term planning. The tax position flows from those decisions, not the other way around.

If you are considering leaving money in a trust, the right question is not, “Will I pay inheritance tax?” The right question is, “What am I trying to achieve, and is a trust the right tool to do it?”

From experience, when that question is answered honestly, the tax outcome usually becomes much clearer, and far less frightening.

If you would like to explore related Inheritance Tax guidance, you may find Do I pay Inheritance Tax on property I live in and Do pensions count towards Inheritance Tax useful. For broader inheritance tax guidance, visit our inheritance tax hub.