Guest Insight: Gifting and Lifetime Trusts: The legal foundations of passing on wealth

Guest Insights are a thought leadership series highlighting the perspectives of our professional colleagues and industry experts we work with. Each article is a guest contribution and reflects the views of the author.

For families with assets above a certain threshold, what happens after death is rarely a simple matter of “everything goes to the children.” Where an estate exceeds £325,000 and is not left to a spouse or civil partner, Inheritance Tax (IHT) can be substantial. With additional reliefs and allowances, the effective threshold can reach up to £1 million  for some married couples or civil partners, subject to specific conditions being met, but for some households this tax is still a meaningful concern.

One option for reducing future IHT exposure is making gifts during your lifetime. This could be outright gifts or putting assets into a trust. Each has its own rules and pitfalls, and trusts in particular suffer from a long history of being misunderstood. This insight intends to highlight gifting, lifetime trusts and the legal foundations related to these.

Lifetime gifting

Giving assets away while alive is the most straightforward planning tool. HMRC provides several exemptions:

• Annual exemption: £3,000 per tax year. Unused allowance can be carried forward one year (up to £6,000).
• Small gifts: up to £250 to any number of individuals each tax year, provided they haven’t also received part of your £3,000 annual exemption.
• Wedding and civil partnership gifts: exempt up to £5,000 for a child, £2,500 for a grandchild, £1,000 for anyone else.
• Regular gifts from surplus income: exempt entirely if habitual, paid from income (not capital) and not affecting your standard of living. HMRC will expect documented evidence.
• Potentially Exempt Transfers (PETs): larger gifts outside these exemptions. Survive seven years and there’s no IHT. Die sooner and the gift becomes chargeable at up to 40%, with taper relief between years three and seven.

Used consistently, these exemptions can shift meaningful value out of an estate without the complexity of a trust.

Trusts: the basics

A trust separates the ownership of assets from the benefit of them. Three roles sit at its heart:

• The settlor transfers assets in and sets the terms via the trust deed.
• The trustees become legal owners, follow the deed, handle tax, and manage distributions.
• The beneficiaries stand to benefit through income, capital, or both.

A lifetime trust is created by executing a deed and transferring assets into trustee names.

A warning on lifetime trusts

Products marketed as “Family Protection Trusts” or “Asset Protection Trusts” are often sold on bold promises: “reducing IHT liability” or “sidestepping probate”. We see trusts that are poorly understood at the point of creation that have since produced avoidable tax liabilities or other issues. A lifetime trust should only be used by someone who understands what they are signing up to and will measurably benefit. It is wise to take financial advice first then legal advice second.

Four common lifetime trust types

• Bare trusts: The simplest form. The trustee is a custodian only; the beneficiary has an immediate right to income and capital. The standard vehicle for gifts to minors, who gain full control at 18. Income and gains are taxed in the beneficiary’s hands; the gift is a PET.
• Discretionary trusts: Trustees have full discretion over how, when and to whom to distribute among a defined class of beneficiaries. No one has guaranteed entitlement.
• Vulnerable persons trusts: Designed to support someone who cannot manage their own affairs due to long-term disability. Can be taxed as though income and gains were the beneficiary’s own. Means-tested benefits are preserved. On the beneficiary’s death, assets form part of their estate.
• Pilot trusts: Typically discretionary trusts set up with a nominal sum, then left dormant until a larger sum arrives (e.g. death-in-service, pension lump sum, legacy). They keep substantial death benefits outside a surviving partner’s estate. No immediate tax cost; the relevant property regime applies once assets arrive.

Five issues every settlor should consider

1. Tax friction: Putting more than the nil-rate band into a lifetime trust could trigger an immediate 20% IHT charge, on top of ten-year and exit charges. Lifetime trusts can also undermine the availability of the Residence Nil-Rate Band.
2. Trustee responsibility: Trustees have fiduciary duty to act in the best interest of the beneficiaries, follow the trust deed, take advice, keep records, and exercise reasonable care. Any breaches to their fiduciary duty could hold the trustees personally liable.
3. Loss of control: Once assets move into the trust, they are no longer ‘yours’. They now belong to the trust.
4. Gift with reservation of benefit: A gift only works for IHT if genuinely outright. Transferring a home into a trust while continuing to live in it rent-free means HMRC treats it as still part of your estate. You would have to pay a full market rent to continue living there.
5. Deliberate deprivation of assets: If a local authority concludes a trust was created to avoid care fees, it can disregard the trust and assess the assets as still yours.

A sensible sequence

1. Financial advice first: a financial forecast tells you what you need for retirement and can afford to gift.
2. Legal advice: a legal professional drafts the deed and handles formal creation.
3. Transfer: the assets are transferred into the trustees names.
4. Administer: the trustees then deal with the trust assets under the rules set out in the trust deed.

A separate compliance step catches many trustees out: most lifetime trusts must be registered with HMRC via the Trust Registration Service within 90 days. Where there is more than one trustee, only one acts as “lead trustee.” Each trust needs its own Government Gateway ID, separate from personal tax accounts. Registration can be delegated to a solicitor or tax adviser.

Lifetime gifting and lifetime trusts can be powerful planning tools

There are many systems in place, reliefs and benefits to support individuals in their estate planning, however doing it right is important. Done well, lifetime gifting and lifetime trusts can be powerful planning tools. Done casually or sold on the back of bold promises create more problems than they solve. Take financial advice, take legal advice and only commit once you understand what the structure is doing and why.

 

Please note:

Guest articles are provided for general information only and do not constitute financial advice. Any third-party services mentioned are separate from Flying Colours and may not be regulated by the Financial Conduct Authority.

All information is correct at the time of writing and is subject to change in the future.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.

The Financial Conduct Authority does not regulate estate planning, tax planning, trusts, or Will writing.

 

Hannah Kavoosi

Hannah Kavoosi is an Estate Planning Solicitor working at Octopus Legacy. Octopus Legacy offers a full range of estate planning services, including wills, trusts, and lasting powers of attorney, alongside a dedicated bereavement platform and probate services through our SRA-regulated law firm, Octopus Legal.