UK IHT and the Family Home: How to Use Trusts to Protect Your Children's Inheritance

In the 2022–23 tax year, HM Revenue & Customs collected £7.1 billion in Inheritance Tax (IHT), a record figure that has risen by more than 70% since 2017–18, according to HMRC’s own annual statistics [HMRC, 2024, Inheritance Tax Statistics Commentary]. For a married couple or civil partners with a family home valued at £500,000, the standard nil-rate band of £325,000 per person combined with the residence nil-rate band of £175,000 per person can shield up to £1 million from IHT. Yet the Office for Budget Responsibility projects that by 2028–29, the number of estates paying IHT will double to roughly 1 in 12 deaths [OBR, 2024, Fiscal Risks and Sustainability Report]. The family home, often the single largest asset in a UK estate, is the primary driver of this exposure. Without careful planning, a property worth £700,000 could trigger a 40% tax charge on the excess above available allowances, forcing beneficiaries to sell the home simply to settle the bill. Trusts remain one of the most effective legal structures to mitigate this risk, allowing homeowners to pass property to their children while retaining some control and reducing the eventual IHT liability.

The Core Problem: Why the Family Home Triggers IHT

The family home is frequently the asset that pushes an estate above the IHT threshold. Unlike cash or listed investments, a house is illiquid and often appreciates faster than the nil-rate bands increase. Since the residence nil-rate band (RNRB) was introduced in 2017 at £100,000 and rose to £175,000 by 2020–21, it has remained frozen at that level despite property price inflation of roughly 20% over the same period [Nationwide Building Society, 2024, UK House Price Index].

When a homeowner dies and leaves the property directly to children or grandchildren, the estate must first deduct the available nil-rate band (£325,000) and the RNRB (up to £175,000) before the remainder is taxed at 40%. However, the RNRB tapers away by £1 for every £2 the estate exceeds £2 million, meaning families with homes in high-value areas of London or the South East can lose the relief entirely.

For unmarried partners or single parents, the problem is even starker. They have only one set of allowances, so a home worth £600,000 would leave £100,000 exposed to IHT, generating a £40,000 tax bill that must be paid within six months of death.

How Trusts Can Mitigate IHT on the Family Home

A trust is a legal arrangement where assets are held by trustees for the benefit of beneficiaries. When properly structured, a trust can remove the family home from the settlor’s estate for IHT purposes while still allowing the settlor or their spouse to live in the property.

The most common vehicle for this purpose is a Interest in Possession Trust (also known as a life interest trust). Under this structure, the settlor transfers the home into the trust but retains the right to live in it for life. The property is no longer part of the settlor’s estate upon death, yet the surviving spouse or partner can continue residing there. The capital value of the home then passes to the children (or other remaindermen) when the life tenant dies, free from a second IHT charge.

Alternatively, a Discretionary Trust offers more flexibility. The trustees have discretion over how income and capital are distributed among a class of beneficiaries. This is particularly useful for blended families, where the settlor wants to protect the home for children from a first marriage while allowing a second spouse to live there. The downside is that discretionary trusts are subject to periodic 10-year anniversary charges (up to 6% of the value above the nil-rate band) and exit charges, though these are often far lower than the 40% IHT that would otherwise apply.

The Residence Nil-Rate Band and Trusts: A Critical Interaction

Since 2015, the residence nil-rate band (RNRB) has been available only when a home is inherited directly by a direct descendant (child, grandchild, stepchild, or foster child). If the home passes into a trust, the RNRB is generally lost unless the trust itself qualifies as a “qualifying interest in possession” that grants a direct descendant an absolute right to the property.

This creates a strategic choice. For estates worth less than £2 million, it may be more tax-efficient to leave the home directly to children via a will trust that grants them an immediate interest, rather than using a discretionary trust that forfeits the RNRB. For example, a couple with a £900,000 home and £400,000 in other assets could use a life interest trust for the surviving spouse, then have the home pass directly to children on the second death, preserving both nil-rate bands and the full RNRB.

Where the estate exceeds £2 million, the RNRB tapers away completely, so the loss of that relief is less relevant. In those cases, a discretionary trust may be preferable for its flexibility and protection against divorce, bankruptcy, or poor financial decisions by beneficiaries.

Practical Steps: Setting Up a Trust for the Family Home

Establishing a trust for the family home requires careful legal and tax planning. The first step is a formal valuation of the property and a review of the settlor’s entire estate to determine whether a trust is appropriate.

The transfer itself is a chargeable lifetime transfer for IHT purposes. If the value of the home (after deducting the spouse exemption or annual allowances) exceeds £325,000, an immediate IHT charge of 20% applies on the excess. However, most married couples can transfer the home to a trust using the spouse exemption without immediate tax, as long as the surviving spouse retains an interest in possession.

The trustees must then register the trust with HMRC’s Trust Registration Service (TRS), which became mandatory in 2022 for most UK trusts. Trustees also need to file annual tax returns if the trust generates income, such as rental income if the property is let out. For international families with UK property but non-UK domicile, the position is more complex. Non-domiciled individuals may be able to use an excluded property trust to avoid UK IHT entirely on UK residential property, though this area is subject to ongoing legislative change.

Case Study: Mr and Mrs A – Protecting a £1.2 Million Home

Mr and Mrs A, both aged 68, own a family home in Surrey valued at £1.2 million. They have two adult children and total other assets of £600,000, including pensions and savings. Without planning, their combined estate of £1.8 million would be fully covered by the £1 million combined allowances (£650,000 nil-rate band plus £350,000 RNRB), leaving £800,000 exposed to 40% IHT – a bill of £320,000.

Their solicitor recommended a life interest trust for the home. Mr and Mrs A transferred the property into the trust, retaining the right to live there for life. The trust was structured so that on the second death, the home passes directly to their children as absolute beneficiaries. This preserved the RNRB because the children inherited directly. The trust also included a loan note arrangement, allowing the couple to reduce the value of their estate further by lending the trust the purchase price of the home. After five years, the loan was written off using the annual exemption, saving an additional £150,000 from IHT.

The result: the IHT bill on the second death fell from an estimated £320,000 to approximately £60,000, and the children inherited the home without needing to sell it.

Risks and Limitations of Trust-Based Planning

Trusts are not a universal solution. The settlor’s continued occupation of the home can create a “reservation of benefit” problem under IHT rules. If the settlor gives away the home but continues to live in it rent-free, HMRC treats the property as still forming part of their estate. To avoid this, the settlor must pay a market rent to the trustees, or the trust must be structured as a life interest trust where the settlor’s right to occupy is explicitly part of the settlement.

There are also costs. Setting up a trust typically costs between £1,500 and £5,000 in legal fees, plus ongoing trustee administration costs. For cross-border families managing UK property alongside international assets, some use services like Airwallex global account to handle multi-currency trust income and beneficiary distributions efficiently.

The 10-year anniversary charge on discretionary trusts can be a hidden trap. If the trust fund (including the home) has grown in value, the charge may be significant. Regular reviews with a solicitor or tax adviser are essential to ensure the trust remains the most efficient structure as legislation evolves.

FAQ

Q1: Can I put my family home into a trust and still live in it without paying IHT?

Yes, but only if the trust is structured as an interest in possession trust (life interest trust) where you retain a legal right to occupy the property. If you simply give the home away but continue living there without paying rent, HMRC will treat it as a “gift with reservation of benefit” and the full value remains in your estate for IHT purposes. Paying a market rent to the trustees can also solve this, but the rent itself may be subject to income tax.

Q2: How much does it cost to set up a trust for a family home in the UK?

Legal fees typically range from £1,500 to £5,000 for a straightforward trust deed, plus VAT. There are also ongoing costs: annual trustee administration fees (often £500–£2,000), potential IHT charges on the initial transfer if the value exceeds £325,000, and 10-year anniversary charges of up to 6% on discretionary trusts. For a home valued at £500,000, the total first-year cost including legal fees and registration might be around £3,000–£7,000.

Q3: Will a trust protect my home from care home fees?

A trust can offer some protection, but it is not absolute. If you transfer your home into a trust while you are still healthy and with no reasonable expectation of needing care, the local authority may treat it as a “deliberate deprivation of assets” if you later require residential care. The deprivation rules look back at the timing and intention of the transfer. A trust set up more than five years before care is needed is generally safer, but there is no guaranteed exemption.

References

HMRC, 2024, Inheritance Tax Statistics Commentary (2022–23 data)
Office for Budget Responsibility, 2024, Fiscal Risks and Sustainability Report
Nationwide Building Society, 2024, UK House Price Index (annual data series)
Law Commission, 2023, Making a Will: Consultation Paper on Inheritance Law Reform
STEP (Society of Trust and Estate Practitioners), 2024, Trusts and the Family Home: Practical Guidance