A life interest trust usually gives one person the present right to the trust income, or the present use of trust assets, during that person’s lifetime. Where the trust contains a qualifying life interest (broadly, an interest in possession already in existence before 22 March 2006), trustees need to check more than the trust deed. The inheritance tax and capital gains tax consequences can differ materially from those of a relevant property trust, particularly on the life tenant’s death or on any lifetime restructuring.
The inheritance tax charge can arise on death even though the assets are held in trust
Where there is a qualifying life interest, the life tenant is generally treated for inheritance tax purposes as owning the trust assets in which that interest subsists. On the life tenant’s death, those trust assets may therefore fall into the death estate even though legal title remains with the trustees.
The practical consequence is that trustees cannot review the trust in isolation. They need to consider the value of the trust fund alongside the life tenant’s own estate, because the combined position may affect the rate of tax, the use of nil-rate bands and reliefs, and the urgency of any planning.
The trustees are responsible for the IHT attributable to trust assets
Although the charge is calculated by reference to the life tenant’s death estate, the trustees are liable for the inheritance tax attributable to the settled property. Trustees therefore need to plan not only for the amount of tax but also for how it will be funded.
That funding point matters in practice. A trust holding land, private company shares, concentrated portfolios or other illiquid assets may face a tax liability without having ready cash to pay it, which can force a sale at an inconvenient time or require borrowing.
Ending the life interest early may not be an automatic solution
Once trustees identify a possible tax charge on death, the obvious reaction may be to end the life interest during the life tenant’s lifetime in the hope that there is no immediate charge and that the life tenant simply starts a seven-year PET (Potentially Exempt Transfer) clock. That assumption is often wrong.
Before any step is taken, trustees need to establish what happens next to the assets. Do they pass outright to another beneficiary, or do they remain in trust? If they remain in trust, on what terms? Is the former life tenant fully excluded from benefit? Those points determine whether the change is a PET, an immediately chargeable transfer, a gift with reservation problem, or some combination of those issues.
The seven-year rule only helps in the right kind of case
The seven-year survival rule helps only if the termination of the life interest produces a potentially exempt transfer by the life tenant. That usually requires the relevant value to leave the life tenant’s estate rather than simply moving from one trust regime to another. If the assets stay in trust, the analysis is often different.
If the trust continues after the life interest ends, there may be an immediate lifetime IHT charge
If the life interest is brought to an end but the assets remain in the settlement, for example on discretionary trusts for children or grandchildren, the life tenant may make an immediately chargeable transfer at that point. In other words, trustees may exchange a possible death charge later for a lifetime charge now.
Continued access to the trust can create a fresh inheritance tax problem
Ending the existing life interest is not enough if the former life tenant can still benefit from the trust afterwards. If the former life tenant remains within the class of beneficiaries, or can otherwise continue to enjoy the settled property, the arrangements may amount to a gift with reservation of benefit.
That risk typically arises where the life interest ends, the fund stays in trust, and the former life tenant is not excluded in practical terms. The supposed planning may then fail because the property is still treated as relevant to the former life tenant’s estate.
Capital gains tax may point in the opposite direction
Capital gains tax can point in the opposite direction. If the qualifying life interest continues until death, the trustees may obtain a market value uplift on the assets at the life tenant’s death without an immediate trustees’ capital gains tax charge.
That means an inheritance tax driven restructuring can be materially worse overall if it destroys a valuable capital gains tax uplift. The comparison is often most acute where the life tenant is elderly or in poor health and the trust assets stand at large unrealised gains.
Offshore trusts need especially careful review
Where there is an offshore trust, the inheritance tax analysis does not depend only on the trust terms. Trustees also need to identify what non-UK assets are held, when those assets became comprised in the settlement, and whether the structure falls within any surviving excluded property protection.
In some older structures, certain foreign assets may still remain outside the inheritance tax charge. But that is not a blanket exemption for all offshore holdings. Trustees should not assume that switching from one non-UK investment to another preserves the existing treatment. The trust may not qualify for that protection in the first place, and the switch itself may have separate tax consequences.
Older excluded-property structures are sometimes misunderstood
One common error is to assume that a life tenant who is long-term UK resident automatically brings all foreign trust assets into charge on death. Another is to assume that the assets must remain excluded property simply because the settlor was non-UK domiciled when the settlement was created.
Both approaches can misfire. Since 6 April 2025, trustees need to distinguish between older structures or assets that still retain protection under the previous excluded property regime and those that now depend on the settlor’s long-term UK residence status under the new rules. That distinction may determine whether there is a charge on the life tenant’s death, and if so on which assets.
Practical points trustees should review well before any change
Well before any surrender, appointment or restructuring, trustees should review the trust deed powers, the destination of the assets after the change, whether the former life tenant will be fully excluded, the availability of cash to fund any tax, the need for current valuations, the availability of reliefs, and the capital gains tax consequences of each option.
If the trust has offshore features, trustees should also check the governing law, the powers of non-UK trustees, and whether local advice is needed before any step is implemented. Early review usually preserves more options. Waiting until the life tenant is near death, or attempting a last-minute restructure, often narrows the choices and increases execution risk.
The broad lesson is that a qualifying life interest trust cannot be reviewed only as a trust law arrangement. Trustees need to understand the inheritance tax and capital gains tax consequences before a death, before any lifetime termination of the life interest, and before altering the trust’s investments. A step that appears sensible when viewed only through one tax lens may create a larger problem elsewhere.
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.
