Navigating the various trust options which are available can be difficult. This guide provides a concise overview of the principal types of trust, together with their typical uses and potential advantages. The appropriate structure for you will depend on your personal circumstances and objectives, and specialist legal and tax advice should always be obtained before establishing a trust.
What is a trust?
A trust is a legal arrangement where one party (the settlor) transfers assets to another (the trustee) to hold and administer for the benefit of one or more beneficiaries. This can be in a person's lifetime, known as a lifetime settlement, or set up in their Will, known as a Will trust. Trusts can be used for a variety of purposes, including preserving family wealth, providing for beneficiaries while retaining control of when and how assets pass to them, and, in some circumstances, mitigating Inheritance Tax exposure.
Each trust structure has its own characteristics and practical applications. The most common include bare trusts, discretionary trusts, interest in possession trusts and charitable trusts.
1. Bare trusts
Bare trusts are the simplest form of trust. Under a bare trust, the trustee holds the assets in their name, but the beneficiary has an absolute right to both income and capital. An adult beneficiary can access the trust fund at any time. The specified beneficiary can’t be changed, even if it’s no longer desirable for them to receive the trust benefits. So, the settlor needs to be certain about the named beneficiary or beneficiaries before setting up the trust.
Who is it for? Bare trusts are commonly used by parents and grandparents who wish to make gifts to minors. The minor beneficiary is absolutely entitled to the asset at the creation of the trust, however upon reaching 18 they are able to have the asset transferred to them and exercise control themselves. They offer simplicity and clarity as to the beneficiary’s position.
Tax implications: Assets held on bare trust are generally treated as belonging to the beneficiary for tax purposes, so income and capital gains are usually taxed at the beneficiary's marginal tax rate. Where a parent creates a bare trust for an unmarried minor child, special parental settlements legislation may apply. If gross income arising from the parent's gift exceeds £100 per tax year, the income is generally treated as the parent's income for income tax purposes.
For Inheritance Tax purposes, a gift into a bare trust is ordinarily treated as a Potentially Exempt Transfer, meaning it may fall outside the settlor’s estate for tax purposes if they survive for at least seven years from the date of the gift. There are no ongoing Inheritance Tax charges for the trust; however, if the beneficiary dies before the trust is wound up, the assets are included in their taxable estate.
2. Discretionary trusts
A discretionary trust offers the settlor greater flexibility than a bare trust. Trustees of discretionary trusts can decide which of the potential beneficiaries should benefit, when, and to what extent. This enables the trustees to respond to beneficiaries’ changing needs and circumstances over time. The trustees must act in the best interests of the beneficiaries and follow the trust deed.
Who is it for? Discretionary trusts are often used for family wealth planning and can be an effective tool when the aim is to provide for multiple generations over a long period. They can protect assets from misuse and allow money to be managed for people who may not be ready to handle substantial assets themselves. They are also useful when the settlor wants flexibility, such as the ability to change who benefits over time. This makes them popular in situations where circumstances may change, such as blended families or shifting financial needs.
Income and Capital Gains Tax implications: Discretionary trusts are subject to their own income tax regime. Trustees are generally liable to income tax at the trust rates, currently 45% on most income and 39.35% on dividend income, subject to the applicable trust taxation rules.
Capital gains are charged at 24%, with the annual allowance being £1,500 (within the 2026/27 tax year). If assets are moved into the trust by the settlor, holdover relief can often be claimed to delay the tax until the assets leave the trust.
Inheritance Tax implications: When a settlor transfers assets into a discretionary trust during their lifetime, the transfer is treated as a Chargeable Lifetime Transfer. A 20% entry charge on anything over the nil-rate band (£325,000 as at the 2026/27 tax year) must be paid. This is not the case if a discretionary trust is established in a Will.
Every ten years, a discretionary trust may be subject to a periodic charge of up to 6% of the value of the trust assets above the trust’s available nil-rate band. The calculation takes into account the trust’s value at the anniversary and any previous distributions.
When capital is distributed to the beneficiaries, an exit charge may apply. The rules are complex but generally, if capital is distributed within the first ten years and an entry charge wasn’t paid, there is no exit charge. If capital is distributed after the first ten years, the exit charge is based on a proportion of the periodic charge at the last ten-year anniversary.
3. Interest in possession trusts
An interest in possession (IIP) trust gives a beneficiary, known as a life tenant, the right to receive income generated by the trust assets or the right to reside at a property for a set duration (which could be their lifetime, or a shorter period). The underlying capital is retained for other beneficiaries, known as remaindermen. When the life interest ends, the remaindermen become absolutely entitled to the capital.
Who is it for? IIP trusts are commonly used where it is desirable for income or a right to reside at a property to be available to a spouse or other family member during their lifetime, while preserving the capital for children or other beneficiaries in the longer term. It is often used in estate planning for blended families.
Tax implications: Any income generated by the trust (e.g. rental income from a property or interest from investments) is treated as the life tenant's personal income if the income is appointed directly to the life tenant. It would then be taxed at their personal marginal rate. If the income passes through the trust first, it will be charged at 45%, with the life tenant able to reclaim the tax above what they would usually pay.
For Inheritance Tax purposes, an IIP trust will be treated as forming part of the estate of the life tenant entitled to the income. It could therefore be subject to 40% Inheritance Tax. Certain qualifying interest in possession trusts are not subject to ten-year periodic and exit charges. However, many interest in possession trusts created during lifetime since 22 March 2006 fall within the relevant property regime and may be subject to such charges.
4. Charitable trusts
Charitable trusts are established for charitable purposes and must operate for the public benefit. They must satisfy the applicable legal requirements, including those set out in charity legislation, and can offer significant tax advantages when properly constituted.
Who is it for? Charitable trusts are well suited to individuals and families who wish to pursue philanthropic objectives or establish a lasting charitable legacy.
Tax implications: Charitable trusts can benefit from substantial exemptions where the relevant statutory conditions are satisfied.
5. Trusts for vulnerable persons
A trust for vulnerable persons is a trust established for the primary benefit of a named beneficiary, most commonly a disabled person who is in receipt of particular benefits or a child under 18 who has lost a parent. A vulnerable beneficiary can also be someone who is unable to manage their own affairs because of a mental health condition covered by the Mental Health Act 1983.
These trusts are often used to safeguard assets for someone who lacks the capacity to handle finances, while allowing trustees to apply funds in a controlled way for that person’s benefit. It is important to note that any capital leaving the trust must be used for the benefit of the vulnerable beneficiary, and that the income is for their benefit during their lifetime. Although other people can be named as potential beneficiaries, the trustees are limited as to how much the other beneficiaries can receive – currently being the lower of £3,000 per tax year or 3% of the maximum value of the trust fund.
Who is it for? Trusts for vulnerable persons are commonly used where a family wishes to provide financial support for a disabled or otherwise vulnerable beneficiary without giving them outright control of the assets. They can be particularly useful where the beneficiary may need long-term support, where there is concern about financial management or undue influence, or where a settlor wants assets to be protected and administered by trustees for that person’s ongoing welfare.
Tax implications: Special tax treatment is generally available for qualifying trusts for vulnerable beneficiaries. Subject to the relevant conditions being satisfied and a vulnerable beneficiary election being made with HMRC, Income Tax and Capital Gains Tax can broadly be charged as if the vulnerable beneficiary owned the assets personally, which may reduce the overall tax burden. Qualifying disabled person's trusts generally avoid ten-year and exit charges; however, the value of the trust will aggregate with the vulnerable person’s own assets for Inheritance Tax.
Setting up a trust: key considerations
Establishing a trust is a significant decision and should be approached with careful planning. Some of the principal considerations include:
Purpose of the trust: Be clear about what you are trying to achieve. For example, are you seeking to provide for future generations, support a dependent, or further charitable aims?
Choosing trustees: Trustees play a central role in the administration of a trust, so it is important to appoint individuals or professionals who understand your intentions and have the experience to manage the trust effectively.
Tax implications: Each type of trust is subject to its own tax treatment, which may affect both the settlor and the beneficiaries. Advice from a tax specialist can help ensure the chosen structure is as efficient as possible.
Legal advice: Trusts are complex legal arrangements, and errors in drafting or administration may lead to unintended tax consequences or disputes. Taking legal advice at an early stage can help ensure that the trust is properly structured and aligned with your objectives.
Keeping the trust under review: Family circumstances, tax legislation and personal objectives can change over time. Periodic reviews can help ensure the trust continues to meet its intended purpose.
How TWM can help
TWM Solicitors’ Private Client team advises individuals, families and trustees on all aspects of trusts, from choosing the most appropriate structure to setting up, administering and bringing trusts to an end.
If you would like advice on creating a trust or need assistance with an existing trust arrangement, please contact our Private Client team for an initial, no-obligation consultation.