What are the different types of trust in the UK and how are they taxed?

Full answer

Trusts are legal arrangements where one person (the settlor) transfers assets to trustees to hold for the benefit of beneficiaries. UK trust law and tax is a complex specialist area, but the four main types and their tax treatment are summarised below. 1. Bare trust (also called an absolute trust): The beneficiary has an immediate and absolute right to both the trust income and capital. The trustee holds the assets but has no discretion -- they merely administer the trust on the beneficiary's behalf. Income tax: all income and gains are taxed on the beneficiary at their marginal rate as if they owned the assets directly. Parental settlement rules: if a parent funds a bare trust for their minor child and the income exceeds GBP 100/year, the income is treated as the parent's for tax. This GBP 100 limit is per parent, per child. IHT: a gift into a bare trust is a Potentially Exempt Transfer (PET) -- outside the estate after 7 years. CGT: calculated at the beneficiary's rates and using their Annual Exempt Amount. Common use: Junior ISA alternatives, children's savings. 2. Interest in possession (IIP) trust (also called a life interest trust): A named beneficiary (the 'life tenant') has an immediate entitlement to the trust income as it arises but not to capital. On their death (or when the life interest ends), the capital passes to remaindermen. Income tax: income is taxed on the life tenant at their marginal rates. Trustees pay income tax at basic rate (20% on interest, 8.75% on dividends) and the life tenant gets credit for tax paid and pays any higher-rate supplement. CGT: trustees pay CGT at 20% (or 24% for residential property from 2024) above the trust's AEA (half the individual AEA, i.e. GBP 1,500 for 2026/27 for most trusts, though there are exceptions for trusts for disabled persons). IHT: for trusts created on or after 22 March 2006, most IIP trusts are 'relevant property' trusts subject to periodic and exit charges (see discretionary trust below) UNLESS the trust was created on death (a 'qualifying IIP') or qualifies as an immediate post-death interest (IPDI). The life tenant's interest in an IPDI is treated as part of their estate for IHT. 3. Discretionary trust: Trustees have full discretion over how to allocate income and capital among a class of potential beneficiaries. No beneficiary has a fixed entitlement until the trustees exercise their discretion. Income tax: trustees pay income tax at 45% (the 'trust rate') on income above GBP 1,000 per year (the 'standard rate band' -- shared among all trusts made by the same settlor). Dividend income is taxed at 39.35%. Distributions to beneficiaries carry a 45% tax credit; beneficiaries can reclaim the excess if they are basic-rate taxpayers. IHT: 'relevant property' regime applies: (a) entry charge (CLT): if the value settled exceeds the settlor's available NRB (GBP 325,000 for 2026/27), a 20% lifetime charge applies to the excess; (b) 10-year periodic charge: every 10 years, up to 6% of the trust's value above the NRB is charged; (c) exit charges: proportionate charges when assets are distributed or leave the trust. CGT: trustees pay CGT at 20%/24% with a reduced AEA. Common uses: IHT planning, protecting assets for vulnerable beneficiaries, asset protection. 4. Accumulation trust: Historically popular, allowing income to be accumulated and added to capital. Since Finance Act 2006, most new accumulation trusts are treated as discretionary trusts for tax purposes. Trusts for disabled persons and vulnerable beneficiaries have special concessionary rules that significantly reduce tax to broadly the rate the beneficiary would pay personally. These are available for trusts where the disabled person has at least 50% of the benefit entitlement. Summar: the choice of trust type has profound consequences for ongoing taxation and IHT exposure. Always take specialist legal and tax advice.

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