Non-settlor interested trusts is one of the most effective ways to reduce inheritance tax on family wealth while maintaining flexibility for beneficiaries. Unlike settlor-interested trusts where the person creating the trust can benefit, non-settlor interested trusts exclude the settlor and their spouse from receiving trust income or capital.
This exclusion creates significant inheritance tax advantages when transferring property, investments, or cash to children and grandchildren, particularly during downsizing or estate planning.
Let’s see how this works
What Is a Non-Settlor Interested Trust?
A non-settlor interested trust is an arrangement where you (the settlor) create a trust but exclude yourself and your spouse from any benefit. This means you cannot receive trust income, capital, or enjoy trust assets during your lifetime.
Here’s what it means:
- The settlor creates the trust but receives no benefit
- Beneficiaries (typically children or grandchildren) enjoy the trust assets
- Trustees manage the trust according to your instructions
- The trust exists independently of your estate
- Tax treatment differs significantly from outright gifts
Non-Settlor vs. Settlor-Interested Trusts
The distinction between these trust types fundamentally affects inheritance tax planning because if your client keeps any benefit for themselves, HMRC treats the assets as still belonging to them. No tax savings. The trust becomes pointless.
Here’s how they compare:
| Aspect | Settlor-Interested Trust | Non-Settlor Interested Trust |
| Can settlor benefit? | Yes (may receive income or capital) | No (explicitly excluded) |
| IHT treatment | Assets remain in settlor’s estate | Potentially exempt transfer after 7 years |
| Estate at death | Assets included in taxable estate | Assets excluded (after 7 years) |
| Income tax | Taxed on the settlor | Taxed at trust rates (45% for discretionary trusts) |
| Flexibility | Limited by tax rules | High for beneficiaries |
| Cost | Lower setup costs | Slightly higher complexity |
If you create a trust but retain benefits, inheritance tax authorities will ignore the trust structure and treat assets as remaining in your estate.
A non-settlor interested trust structure ensures you receive no such benefit, solving the problem once and for all.
Inheritance Tax Benefits of Non-Settlor Interested Trusts
1. When you gift assets outright to children, rather than solving the problem, you’ll at best be postponing the problem for a generation. Your children’s estates will be larger, and when they die, inheritance tax will apply again (potentially at 40% on amounts exceeding their nil rate band of £325,000 as of 2025).
A non-settlor interested trust breaks this cycle.
If you survive seven years after transferring the assets to the trust, those assets fall out of your estate completely.
Your children benefit from the assets during their lifetime, but when they die, the trust assets don’t swell their estates because the inheritance tax problem stops with you.
2. Beyond inheritance tax savings, non-settlor interested trusts protect family wealth. Say you give £500,000 to your son/daughter outright and they face financial difficulties (business failure, divorce, creditor claims), that money could be lost.
On the other hand, assets held in a non-settlor interested trust remain protected because they’re not technically owned by beneficiaries. Instead the assets would be in the trust.
3. You decide how trust assets are distributed. Trustees can pay income to beneficiaries regularly, distribute capital at milestones (age 21, 25, 30), or hold assets in perpetuity for future generations.
This flexibility continues even after you’ve passed away, as long as trustees follow your written instructions.
Case Study: Mo’s Downsizing Dilemma
Mo contacted me, facing a common situation. He and his wife owned a £650,000 five-bedroom house and planned to downsize to a £350,000 flat. They wanted to give the larger house to their son, Jeff, and his wife, while ensuring their daughter was treated fairly.
The Problem with Outright Gifts
Mo’s initial plan: gift the £650,000 house to Jeff and give monthly payments to his daughter as compensation. His sister questioned this approach.
Gifting £650,000 to Jeff outright created several problems:
- Double taxation risk: When Mo dies, the gift might be caught by IHT (if he dies within seven years). When Jeff dies later, the now-appreciated house asset is caught again in Jeff’s estate.
- Unfair protection: Jeff’s wealth grew substantially from the gift, but his sister received only modest monthly payments (the original plan suggested five hundred pounds a month). By the wondrous computations of computers, we deduced, assuming zero house price inflation, it would take the daughter 135 years to draw level.
- No asset protection: Jeff’s ownership of the property would expose him to such ills as
- Creditor claims
- Divorce settlements
- Disqualification from means-tested benefits
- Family conflict: An unequal, apparently unfair asset distribution is pregnant with family resentment.
Why the £500 Monthly Payment Plan Can’t Work
Aside from the patience and longevity required to make the £500 start to appear viable, this arrangement has the seeds of:
- Informal debt risk: If Jeff missed a payment due to illness or job loss, or sheer bloody-mindedness, such a missed payment would injure the family relations,
- No legal enforceability: A monthly cash payment of £500 would be eroded by inflation – in contrast with landed property which would almost certainly appreciate in value
- Complications at death: If Jeff died, it remained unclear whether the arrangement transferred to his wife
The Non-Settlor Interested Trust Solution
The solution was for each of Mo and his wife to create a non-settlor interested trust. Mo created a trust that would accept £325,000 worth of house, and his wife would created a property that would accept £325,000 worth of house. That way, they had disposed of the
The fairness benefit: Mo controls exactly how assets are distributed, ensuring both children benefit fairly and future generations inherit wealth that’s already had one inheritance tax exposure, not two or three.
Common Mistakes to Avoid
Creating a Settlor-Interested Trust by Accident
The costliest mistake: drafting a trust that allows the settlor to benefit. This might happen through:
- Vague language not explicitly excluding the settlor
- Allowing the settlor to be a trustee with discretion
- Permitting the settlor to receive income
- Retaining the right to recall assets
Result: The trust is ignored for IHT purposes, and assets remain in your estate.
Failing to Survive the Seven-Year Period
If you die within seven years of creating the non-settlor interested trust, the transfer is caught by IHT. The only preventative to this is to act now – as you know, procrastination is a thief of wealth.
Frequently Asked Questions
Can I be a trustee of my own non-settlor interested trust?
No. If you’re a trustee with discretion over distributions, you might be deemed to benefit, converting it to a settlor-interested trust. Your spouse also cannot be a trustee. A professional trustee or your adult child can serve.
What happens if I need to use the trust assets?
You cannot access trust assets. That’s the point. If you need the assets, don’t put them in a non-settlor interested trust. Plan alternative arrangements for assets you might need.
How does downsizing affect the residence nil rate band?
The residence nil rate band (£175,000 additional allowance for your main residence) can transfer to a trust if specific conditions are met. However, the trust must be structured correctly.
Next Steps
Your next step: Book a consultation with me to review your specific circumstances, run tax projections, and recommend the optimal structure for your family.
The difference between sound planning and poor planning isn’t complexity. It’s precision. Mo’s initial plan would have cost his family approximately £192,000 in unnecessary inheritance tax (40% on the excess over his daughter’s nil rate band).
The non-settlor interested trust solution I recommended eliminated that cost entirely. Your family’s situation is unique. Get professional advice tailored to your circumstances, and ensure your wealth is structured to protect what you’ve worked a lifetime to build.