How to generate tax free income

                                                Generating Tax Free Income!

You may be thinking of ways to mange your exposure to inheritance tax by making provision for your children and/or grandchildren.

One way is to gifts assets directly to family members but there is always a risk of it being spent immediately or it could be swallowed up in divorce proceedings if they are in the process of a marital break-up.

What is the Solution?

Rather than make an outright gift direct to the child or grandchild a trust could be created which would offer greater protection against the issues mentioned above.

You could appoint yourself as a trustee so that you can continue to be involved in investment decisions and decide when money should be released from the trust to a beneficiary in terms or income and/or capital.

How to generate tax-free income using a Trust

Another benefit of making gifts via a trust is that, in certain circumstances, you can generate tax-free income in the hands of the beneficiary who has received income from the trust.

The trustees of a discretionary trust pay income tax at 20% on the first £1,000 of their income (7.5% on dividend income) and 45% on the balance (38.1% on dividends).  Whilst this may be higher than your current rate of income tax do not worry as help is at hand.

If the trustees make income distributions to a beneficiary, the income tax that they have paid is credited to the beneficiary who is receiving the income. Therefore, if the beneficiary pays tax at a lower rate than 45% then they can recover the excess from HM Revenue & Customs through their self-assessment tax return.


The trustees of the ABC Trust receive gross rental income of £10,000. Ignoring the £1,000 basic rate band the trustees will pay income tax of £4,500 on this income leaving a sum of £5,500 available for distribution to one or more of the beneficiaries of the trust.

The trustees decide to make an income distribution to John of £5,500. John is studying at university and has no other income.

For tax purposes John is deemed to receive gross income of £10,000 with a tax credit of £4,500. As John has no other income sources the gross trust income he has received is covered by his personal allowance which for the current tax year, 6 April 2021 to 5 April 2022, is £12,570.  John can submit a tax repayment to HM Revenue & Customs to recover the income tax of £4,500 paid by the trustees, thereby generating tax free income in his hands.

A Word of Warning!

The above planning will not work if the beneficiaries of the trust are your children and are under the age of 18. If you have created the trust and trust income is distributed to your minor children, it is treated as your income for tax purposes.  

This type of planning works very well if the beneficiaries are your children and are aged 18 or over or your grandchildren (any age). This is because the income will be treated as their own for income tax purposes.

For more information call Malcolm Emery on 07708 613 789 or email him at

Posted By: Malcolm Emery
Posted: 30 September 2021
2021 42 30 359 How to generate tax free income