Deed of Variation, creating Life Interest Trust

The situation is as follows. Husband has died leaving an estate of £375,000 to his adult son by Will. Wife has survived Husband and is in care home (self-funded from her own assets). Wife is very elderly, has dementia and is not expected to live for more than 2 or 3 years. Wife’s estate is already below the nil rate band and will continue to decrease due to care fees.

It has been suggested that son executes a Deed of Variation, leaving his mother a life interest(IPDI) in £50,000, with son named as the remainderman. The intent is that this reduces the IHT on Husband’s death to nil and even with the aggregation of the trust fund, the Wife’s estate will be below her nil rate band. Wife does not have capacity and there is no suggestion that she would give up the life interest after a short period. Son is aware that the income from the trust fund will be payable to his mother until her death.

Does anyone see a particular problem with what is being suggested?

The Trust would be Settlor-interested with the son as the remainderman and so, whilst the income would be payable to the Wife as life tenant, the son would pay tax on the income as the Settlor. I am having a brain freeze on this point; if the Settlor is taxed on the income is that the end of it? Or is the Wife as life tenant also taxed on the income?

There are adult grandchildren and I suppose it would be more straightforward for them to be named as the remaindermen (assuming Son is happy to forego the £50,000).

Any comments or pointers greatly appreciated.

Steve Carter
Setfords Solicitors

Provided the widow survives 2 years from the death, the variation should
be effective. However, if her life interest determines within the 2
years, I understand s.142 IHTA will cause this to be ignored for iht.

Paul Saunders

Paul, thank you for responding.

I will look again at the point on the death of the life tenant within 2 years, but PLC says:-

Section 142(4) is an anti-avoidance measure, aimed, for example, at the creation of a short-term interest for a surviving spouse followed by an absolute gift of the residuary estate to the couple’s children. However, HMRC accepts that an IIP trust that ends when the life tenant himself dies within two years of a deceased’s death is not caught by section 142(4). The reason is that it is the death that ends the trust, not the terms of the variation.

It is the practicalities after making the variation that I am struggling to get my head around. The trustees would need to complete an annual Tax Return and pay tax on the income (unless they mandate the income to the life tenant?). The Settlor would need to include the trust income in his Tax Return and pay any additional tax due, with a credit for any tax paid by the trustees. Does the life tenant also include the income in her Tax Return?

Steve Carter
Setfords Solicitors

The life tenant does not include the income on her return. In the circumstances I would not suggest mandating the income to the life tenant because that will leave the trustees with no income out of which to pay the settlor’s tax bill (he is entitled to be reimbursed out of the trust income).

Paul Davies

1 Like