Types of Trusts in the UK and How They Are Taxed

Trusts are commonly used for family planning, asset protection, succession planning and providing for children or vulnerable beneficiaries in a controlled way.

They can be extremely effective, but the tax rules are complex and the best structure depends on what you are trying to achieve.

This guide explains the main types of trusts and gives a practical overview of how they are taxed in the UK.

Note: Tax rules change and the exact tax position depends on the trust deed, the beneficiaries and the type of assets held.

Key Trust Roles Explained

Settlor
The person who creates the trust and places assets into it.

Trustees
The individuals who control the trust assets and make decisions.

Beneficiaries
The people who benefit from the trust income or capital.

From a tax perspective, the type of trust is largely determined by who has rights to income and capital and how much discretion trustees have.

The Main Types of Trust
1. Bare Trust (Simple Trust)

A bare trust is the simplest form of trust. The beneficiary has an immediate and absolute right to both the income and the capital. Trustees hold the assets in name only and have no real discretion.

Common uses
• Holding assets for children until they reach 18 (16 in Scotland)
• Simple family gifting arrangements

How a Bare Trust is Taxed

Income Tax
Income is normally taxed on the beneficiary as if they owned the asset personally.

Capital Gains Tax
Gains are normally taxed on the beneficiary.

Inheritance Tax
Usually treated as an outright gift to the beneficiary (often a potentially exempt transfer).

Important note
Where parents gift assets to minor children, special “settlements” rules can mean income is taxed on the parent.

2. Interest in Possession Trust (Life Interest Trust)

This trust gives a beneficiary (the life tenant) the right to receive income as it arises. The capital is preserved for other beneficiaries who receive it later.

Common uses
• Wills where a surviving spouse receives income for life
• Passing capital to children after the spouse’s death

How an Interest in Possession Trust is Taxed

Income Tax
Income is generally taxed on the life tenant.

Capital Gains Tax
Trustees usually pay CGT on gains.

Inheritance Tax
Treatment depends on how the trust was created and whether it qualifies as a protected will trust.

3. Discretionary Trust

In a discretionary trust, no beneficiary has an automatic right to income or capital. Trustees decide who benefits, when and by how much.

Common uses
• Family wealth planning
• Protecting assets for children or vulnerable beneficiaries
• Situations where future needs are uncertain

How a Discretionary Trust is Taxed

Income Tax
Income is normally taxed at higher trust rates.
Beneficiaries may reclaim tax when income is distributed depending on their own tax band.

Capital Gains Tax
Trustees pay CGT on gains and receive a reduced annual CGT allowance.

Inheritance Tax
Usually falls under the “relevant property” regime, meaning entry, 10-year and exit charges may apply.

4. Accumulation Trusts

These trusts allow income to be retained and added to capital rather than paid out.

In practice, many of these now operate within discretionary trust rules.

Tax treatment depends on the underlying trust structure. Accumulating income does not avoid tax; trustees may still be taxed at trust rates.

5. Settlor-Interested Trusts

This is a tax concept rather than a separate trust type.

If the settlor or certain connected persons can benefit from the trust, anti-avoidance rules apply.

How They Are Taxed

Income Tax
Income may be taxed on the settlor instead of the trust.

Capital Gains Tax
Gains may be attributed back to the settlor.

These rules are complex and designed to prevent income shifting.

6. Trusts for Vulnerable Beneficiaries

Special rules exist for trusts set up for certain vulnerable beneficiaries, including disabled beneficiary trusts.

Where conditions are met, more favourable tax treatment can apply so the trust is taxed closer to the beneficiary’s personal tax position.

7. Charitable Trusts

Charitable trusts may qualify for significant tax reliefs and exemptions.

Income and gains can often be exempt from tax where conditions are met, and gifts to charity can reduce inheritance tax.

How Trusts Are Taxed – The Three Main Taxes
Income Tax

Who pays income tax depends on the trust type.

Bare trusts
Income taxed on the beneficiary.

Interest in possession trusts
Income taxed on the life tenant.

Discretionary trusts
Income usually taxed at higher trust rates, with beneficiaries able to reclaim tax when income is paid out.

Settlor-interested trusts
Income may be taxed on the settlor.

Trustees may also have to register the trust and submit tax returns.

Capital Gains Tax (CGT)

CGT arises when trustees sell assets such as property or shares.

Bare trusts
Gains taxed on the beneficiary.

Most other trusts
Trustees pay CGT and receive a smaller annual exemption than individuals.

Hold-over relief may be available when assets are transferred into or out of certain trusts, allowing tax to be deferred.

Inheritance Tax (IHT)

Inheritance tax is often the most important factor when choosing a trust.

Relevant Property Trusts (common for discretionary trusts)

Entry charge
Possible IHT when assets are placed into trust during lifetime.

10-year charge
Possible IHT charge every ten years based on trust value.

Exit charge
Possible IHT when capital leaves the trust.

Interest in Possession Trusts
Different rules may apply, particularly for trusts created in wills.

Nil rate band and other allowances must always be considered.

Practical Considerations

• Many trusts must be registered with HMRC
• Trustees have legal duties to beneficiaries
• Property held in trust can create complex tax reporting
• Minor drafting differences can significantly change tax treatment

Trusts should always be planned carefully before being created.

Which Trust is Best?

There is no single best option.

The right trust depends on your goals, the assets involved and the people who should benefit.

Trusts are as much about control and protection as they are about tax planning.

Frequently Asked Questions

Do trusts always save tax?
No. Some trust structures are taxed more heavily than personal ownership. Trusts are often used for control and protection rather than pure tax saving.

Are trusts only for wealthy families?
No. Trusts can be useful for modest estates, particularly where beneficiaries are young or vulnerable.

Can a trust be changed later?
Changes are sometimes possible but can trigger tax consequences. It is important to choose the right one from the start.