Reply to readers’ queries published by Taxation magazine in April 2025
Reader’s query
A UK client worked in the US for quite a few years from 1998 onwards and, while he was there, he took out a life assurance policy with a US life company.
He assigned the policy which pays out on his death to a discretionary trust for his children and grandchildren who live in the UK. The trustees are UK residents. He continues to pay the annual premiums on the policy.
We are wondering what the tax position will be in the trust when the death benefit is paid. The client is thinking of leaving the UK permanently due to the current high tax regime.
Could this have any impact on the tax position in relation to the life policy?
Reply to reader’s query
First of all, the reply is based on the assumption that all historic points have been correctly dealt with, such as the domicile status of the settlor when the life policy was assigned to the trust, the actuarial value of the life policy when it was settled into the trust and the associated IHT reporting requirements, whether annual premiums were paid by the settlor out of surplus income.
Assuming the settlor leaves the UK on or after 6th April 2025, he may have a 10-year IHT tail to deal with if he has already spent 10 tax years or more in the UK on 6th April 2025 out of the previous 20. If so, the trust will remain within the relevant property regime for the next 10 tax years.
Trustees must ensure that IHT compliance reporting be correctly dealt with if the next 10th anniversary falls within the 10-year tail period. An IHT exit charge appears unlikely, if the trust’s sole or main asset is the life policy.
During the 10-year tail period, it would be advisable for the ongoing annual premiums to be made out of the settlor’s surplus income such that the annual settled funds are IHT exempt. This is particularly relevant if the life policy premiums exceed the £3,000 annual exemption.
If the settlor were to die within the 10-year tail period, the death benefit will not form part of the settlor’s estate because the life policy is held in the discretionary trust from which he cannot benefit.
However, the trust will be a relevant property trust for the rest of the trust term if the settlor dies as an LTR (Long-Term Resident) settlor. In other words, the 10-yearly principal charge and exit charge will be in view on each 10th anniversary of the trust settlement date, as well as on each occasion value of the trust assets leaves the trust, typically upon trustees making a capital distribution.
After the settlor has spent 10 consecutive tax years outside the UK, the trust becomes an excluded property trust. At this point, an exit charge could be due. Trustees must make sure that the IHT compliance reporting is not missed.
If the settlor dies after the 10-year tail period, the trust remains an excluded property trust. In other words, the valuable IHT protection remains in place for the rest of the trust term.
Based on past experience, a settlor may subsequently decide to return to the UK. This is particularly the case if children and grandchildren are all in the UK. The settlor needs to be made aware of potential IHT implications on the trust if he ever intends to do so.
In any event, the UK trustees are potentially liable to income tax at 45%, except for the first £1,000, if settlor’s death gives rise to a chargeable event gain.
This article is for general information only and should not be relied on as a substitute for specific tax advice.
This article is provided for general information only. It does not constitute tax, legal or other professional advice, and should not be relied on as a substitute for specific advice based on your particular circumstances.
