The Biggest Mistake Parents Make When Setting Up a Trust Fund UK

Setting up a trust fund is often seen as a powerful and responsible way for UK parents to protect and manage their wealth for the benefit of their children. Trust funds can offer a wealth of benefits, including ensuring financial security for beneficiaries, safeguarding assets from external risks, and potentially reducing inheritance tax liabilities. However, despite the clear advantages, many parents fall into a critical trap when establishing these trusts — a mistake that can result in costly tax consequences, loss of control over assets, and family disputes down the line.

In this detailed guide, we will explore the biggest mistake parents make when setting up a trust fund UK, why this mistake is so common, and how you can avoid it. We will also provide a thorough overview of the different types of trusts available in the UK, the tax implications involved, and practical advice to help you create a trust fund that truly works for your family’s unique circumstances.

Understanding Trust Funds: What They Are and Why Parents Choose Them

A trust fund is a legal arrangement in which assets such as cash, investments, property, or business interests are transferred to a trustee or trustees who hold and manage these assets for the benefit of one or more beneficiaries, typically the children or other family members. The rules governing how the trust operates are set out in a legal document called a trust deed, which defines when and how assets and income can be distributed.

Many UK parents decide to set up trusts because they provide several significant advantages:

• Control Over Access: Trusts allow parents to control when and how their children receive money, preventing premature access that could lead to reckless spending or financial difficulties at a young age.
• Protection From Risks: Trusts can shield assets from creditors, divorces, or beneficiaries’ poor financial decisions, ensuring that the assets remain available to intended recipients over time.
• Tax Efficiency: When set up correctly, trusts can be a useful tool in reducing inheritance tax exposure and preserving more wealth within the family.
• Multi-Generational Wealth Planning: Trusts enable parents to pass wealth not only to their children but potentially to grandchildren or other future generations, maintaining family wealth across decades.

However, the effectiveness of a trust fund depends heavily on choosing the correct type of trust, clearly outlining the terms, and understanding the legal and tax framework that applies.

What Is the Biggest Mistake in Choosing or Setting Up a Trust?

The single most common mistake parents make when setting up a trust fund in the UK is establishing a trust without a thorough understanding of the different types of trusts, their tax implications, and failing to seek personalised legal and financial advice tailored to their family’s unique needs.

Why does this mistake matter so much? When parents set up a trust without proper guidance:

• They may unintentionally choose a trust type that does not suit their family’s circumstances or objectives.
• Trusts may grant children access to funds too early or restrict access excessively, causing financial difficulties or dissatisfaction.
• Tax liabilities such as inheritance tax or income tax can dramatically reduce the value of the trust assets, undermining the parents’ original intentions.
• Trustees may lack clarity on their powers and responsibilities, which can lead to mismanagement or disputes.
• Family members may be confused or disagree about the distribution, causing long-term conflict.

This mistake often results from a combination of factors including the complex nature of UK trust law, changes in family circumstances, and the temptation to rely on generic advice or low-cost, do-it-yourself options.

Why does This Mistake happen so often?

Several factors contribute to why so many parents fall into this trap:

• Complexity of Trust Law and Tax Rules: UK trusts are governed by a complex web of legal regulations and tax laws that require specialist knowledge to navigate effectively.
• Misunderstanding Trust Options: Many parents confuse the types of trusts available, not realising the differences in control, tax treatment, and administration obligations.
• Changing Family Dynamics: Divorce, remarriage, the birth of additional children, or the onset of disabilities can change family needs and make original trust terms unsuitable.
• Cost Sensitivity: Professional advice and comprehensive trust setup incur upfront costs, and some parents attempt to avoid these costs, only to face much higher expenses later due to mistakes.
• Underestimating Long-Term Implications: Trusts are long-term arrangements, but many parents fail to anticipate how tax laws or family circumstances may evolve.

What are the different types of trust in the UK? Choosing the Right One Matters

Understanding the various types of trusts is essential for parents who want to set up a trust fund that meets their goals. Here’s a deeper look at the most commonly used trusts and what parents should know about each:

1. Bare Trusts (Simple Trusts)

How They Work: In a bare trust, the beneficiary has an immediate and absolute right to the trust assets once they reach the age of 18 (or 16 in Scotland). Until then, the trustees manage the assets.

Benefits:

• Simple to set up and administer.
• Income and gains are taxed at the beneficiary’s rates, which can be advantageous if the beneficiary has little other income.
• No inheritance tax charges once assets pass directly to beneficiaries.

Limitations:

• Parents lose control once the beneficiary reaches adulthood; funds cannot be held back beyond 18.
• Not suitable if parents want to protect assets from potential risks (e.g., poor financial decisions or divorce).

2. Discretionary Trusts

How They Work: Trustees have full discretion on when, how much, and to whom income or capital is distributed among the beneficiaries. Beneficiaries have no automatic entitlement.

Benefits:

• Maximum flexibility and protection, allowing parents to protect vulnerable beneficiaries or delay access until children are mature.
• Can protect assets from creditors, divorces, or other external claims.

Limitations:

• Complex and costly to administer.
• Subject to periodic inheritance tax charges every 10 years on the value of trust assets over the nil-rate band.
• Income and gains are taxed at higher trust rates, which can reduce the overall returns.

3. Interest in Possession Trusts

How They Work: A beneficiary has an immediate right to income generated by the trust assets, but trustees control the capital.

Benefits:

• Provides beneficiaries with steady income while protecting the capital for future use.
• Useful in estate planning to provide income to a surviving spouse while preserving capital for children.

Limitations:

• Less flexibility than discretionary trusts regarding capital distributions.
• Can have complex inheritance tax implications depending on the circumstances.

4. Accumulation and Maintenance Trusts

How They Work: Income generated by the trust is retained and reinvested, growing the capital until beneficiaries reach a certain age.

Benefits:

• Allows the trust fund to grow faster since income is reinvested.
• Provides structured access to assets when beneficiaries reach specified ages.

Limitations:

• Accumulated income is taxed at the trust rates, which are higher than individual rates.
• Beneficiaries cannot access income until the stipulated milestones.

What Tax Implications Should Every Parent Know Before Establishing a Trust?

Trusts are subject to special tax rules, and failure to understand these can severely reduce the value of the fund intended for children:

• Inheritance Tax (IHT): Transfers into most trusts are treated as chargeable lifetime transfers, subject to IHT if they exceed the nil-rate band (£325,000 in 2025). Discretionary trusts face periodic 10-year charges (up to 6%) on assets over this threshold, plus exit charges when assets are distributed. Bare trusts generally do not attract ongoing IHT charges once assets pass to the beneficiary.
• Income Tax: Income generated by trust assets is taxed at the trust rate, which can be as high as 45% on income like interest or rents and 38.1% on dividends, significantly higher than most individuals’ tax rates. This reduces the amount of income available for beneficiaries.
• Capital Gains Tax (CGT): Trusts pay CGT on asset disposals at 20% (or 28% for residential property), with only a small annual exempt amount (£6,000 in 2025/26), compared to individuals (£12,300). This can mean higher tax bills on gains realized within the trust.

Failing to plan for these tax charges can lead to unexpected tax bills that diminish the trust’s value.

How Parents Can Avoid the Biggest Mistake: Expert Advice and Planning Are Key

1. Seek Specialist Legal and Financial Advice from the Outset

Trust law and tax are specialised areas that require expert guidance. An experienced solicitor and financial adviser will help you select the right trust type, draft clear and effective trust terms, and optimise tax efficiency.

2. Define Clear Objectives and Terms in the Trust Deed

Think carefully about:

• The exact age or circumstances when beneficiaries should access funds
• Whether distributions should be lump sums or phased payments
• Protections needed against divorce, bankruptcy

, or creditors

• Contingency plans for unforeseen life events

3. Choose Trustees Wisely and Provide Clear Guidance

Select trustees who will act responsibly and understand their duties. Consider whether to appoint family members, trusted friends, or professional trustees.

4. Plan for Periodic Reviews

Family needs and tax laws change over time. Regularly review and update the trust to keep it effective and aligned with your intentions.

5. Budget Appropriately for Setup and Ongoing Costs

Trusts require professional fees, administration costs, and tax filings. These should be factored into your financial planning.

Additional Practical Tips for Parents Considering a Trust Fund

• Avoid DIY trust kits or generic templates that don’t address your specific needs.
• Communicate openly with your family about your plans to prevent misunderstandings and disputes.
• Keep thorough records of decisions, trustee meetings, and communications.
• Coordinate your trust with your will and broader estate plan for maximum clarity and efficiency.
• Educate your children about the trust’s purpose and terms to set realistic expectations.

Final Thoughts: Setting Up a Trust Fund That Truly Works

The biggest mistake UK parents make when establishing a trust fund is proceeding without fully understanding the complexities involved or seeking specialised, personalised advice. This often leads to choosing the wrong trust type, incurring unnecessary taxes, and losing control over how assets are managed and distributed.

By investing time and effort in careful planning, working with experienced professionals, and clearly defining your objectives, you can establish a trust fund that protects your children’s financial future, minimizes tax exposure, and provides peace of mind that your legacy will be preserved according to your wishes.