Tax treatment of life interest trust for non-exempt life tenant

Trusts Discussion
1

Hello all,

I have a case where I am reviewing a Will for a couple that want to put in place life interest trusts. They are not married and have no children and I want to ensure that I am giving them the correct tax advice. It is my understanding that when you create a life interest trust with a spouse then this qualifies for spouse exemption but where the life tenant is not an exempt beneficiary then the property share passing to them as an IPDI would be chargeable to tax (if the personal allowance is used up). When the life tenant then dies I understand that the value of the life interest property aggregates with their estate and the life tenant’s estate pays tax on the whole value (again, after allowances). My question is, do this mean that you could potentially pay IHT twice on a property put into a life interest trust in this way? Is there a way around this for the life tenant’s estate or should a different set up be advised?
Many thanks

2

If X dies and leaves property on an IPDI for Y (non-spouse) then X’s estate is subject to IHT. On Y’s subsequent death his IPDI s included as part of Y’s estate for IHT purposes. The IHT charge arising on Y’s death attributable to the IPDI is a liability of the trustees not Y’s estate.

EG
Y dies with a free estate £500,000. The IPDI is worth £100,000.
IHT at 40% on 600k ie 240k (ignoring NRB).
100k/600k of 240k (ie 40k) is IHT charge chargeable on trustees (not Y’s estate).

Malcolm Finney

3

As unmarried, consider a NRBDT so locking in the use of the NRB on first death. Course, if property, or share, above NRB, will lead to IHT charge.

The advantage would, if workable, removes aggregation of Trust with the survivor’s estate as not IPDI.

PPR should be available if Trust includes property lived in by survivor.

Usual 10 yearly charges but at 6% max over NRB instead of potential 40%.

4

@maddieharris you ask if the IPDI for a non-exempt beneficiary suffers inheritance tax twice - once on the death of the original testator and again on the death of the beneficiary. You seem to be seeing that as a disadvantage: but really it’s just tax-neutral. If the testator, without making any trust at all, had simply given the property outright to the non-exempt beneficiary, then that too would be inheritance-taxed twice, once on the testator’s death and again at the beneficiary’s death.

5

@maddieharris, if considering @Karl’s solution, you should consider whether there’s any advantage to limiting it to being a NRBDT (which stands for “nil-rate band discretionary trust”). That is, limiting its value to the nil-rate band has no advantage that I can see, where none of the original testator’s estate is exempt. Instead a full discretionary trust of the whole of the property’s value has the advantages (also the disadvantages) which @Karl identifies.

6

Thanks Andrew…you are of course correct that limiting to the NRB may not be advantageous. Full Discretionary Trust would be more favourable if opting for that route.