Life Interest Trust UK (2026): IHT, Income Tax, CGT and When a Life Tenant's Interest Ends

A life interest trust (also called an interest in possession (IIP) trust) is a trust in which one beneficiary — the 'life tenant' — has the right to receive ALL the income produced by the trust fund for their lifetime (or for a fixed period). The underlying capital belongs to the 'remaindermen' who inherit it when the life tenancy ends: (1) THE LIFE TENANT'S RIGHTS: the life tenant has an immediate, absolute right to all net income from the trust as it arises. The trustees must distribute income promptly to the life tenant — they cannot accumulate income without the life tenant's consent (subject to very limited exceptions). The life tenant has no right to the capital — only to income. INCOME includes: bank interest; dividends from shares; rental income from property held by the trust; distributions from collective investments; (2) THE REMAINDERMEN'S RIGHTS: the remaindermen are entitled to the capital. They have no right to income during the life tenant's lifetime. Their interest is deferred — they wait. When the life tenant dies (or the life interest otherwise ends), the capital passes to the remaindermen absolutely. The remaindermen have a contingent interest that becomes absolute on the ending of the life interest; (3) EXAMPLE — TYPICAL STRUCTURE: a husband's will settles his share of the family home and his investment portfolio on trust. His wife has a life interest (right to live in the property and receive investment income for life). Their children are the remaindermen — they inherit the property and investments when the wife dies. This is a very common arrangement in second marriages and in family home trusts; (4) HOW THE TRUST IS CREATED: (a) in a will — the life interest arises on death from the terms of the will; (b) in a lifetime settlement — the settlor transfers assets to trustees and the life tenant benefits immediately. The IHT treatment differs significantly depending on when and how the trust was created (see below); (5) THE TRUSTEES' ROLE: the trustees hold the trust assets, manage the investments, and ensure income is paid to the life tenant. They may have power to advance capital to the life tenant or to a remainderman (depending on the trust deed). Trustees owe duties to both classes of beneficiary and must act impartially between the income beneficiary (life tenant) and the capital beneficiaries (remaindermen).

The Finance Act 2006 fundamentally restructured the IHT treatment of interest in possession trusts: (1) PRE-22 MARCH 2006 — THE OLD RULES: all qualifying IIP trusts fell under IHTA 1984 s.49(1). The life tenant was treated as beneficially entitled to the trust capital — the capital was in the life tenant's estate for IHT and taxed on their death. No periodic charges (10-yearly) or exit charges applied to qualifying IIP trusts. These trusts were tax-efficient because they avoided the relevant property regime; (2) POST-22 MARCH 2006 — THE NEW RULES: Finance Act 2006 restricted the trusts that can qualify for the old IIP treatment. From 22 March 2006, a new IIP created during the settlor's lifetime is NOT a qualifying IIP — it is treated as a RELEVANT PROPERTY TRUST (like a discretionary trust) and is subject to: (a) entry charge at creation (up to 20% if the trust value exceeds the settlor's available NRB at the time of creation); (b) 10-yearly periodic charge (up to 6% every 10 years on the trust's value above the NRB); (c) exit charges when trust assets are distributed. This makes new lifetime IIP trusts significantly less IHT-efficient; (3) QUALIFYING CATEGORIES — IIPS THAT STILL GET THE OLD TREATMENT: the following types of IIP trust still fall under IHTA s.49(1) and avoid periodic charges: (a) IPDI (Immediate Post-Death Interest — IHTA s.49A): a life interest that arises directly from a death — under the will or the intestacy rules. This is the most common qualifying category; (b) TSI (Transitional Serial Interest — IHTA s.49C): a life interest in the same trust that succeeds a pre-2006 qualifying IIP or another TSI. This grandfather provision; (c) Disabled person's trusts (IHTA s.89); (d) Bereaved minor trusts (IHTA s.71A); (e) Age 18-to-25 trusts (IHTA s.71D); (4) THE IPDI — THE KEY CATEGORY FOR WILLS: for trusts created in wills (the vast majority of family life interest trusts), the IPDI category is the relevant one. An IPDI must: (a) arise on the death of the testator or intestate (not a later appointment from a discretionary trust); (b) be an immediate interest in possession (arising directly from the death); (c) the life tenant must have become entitled to it as a result of the death. Where a spouse receives a life interest under a will IPDI, the spouse exemption (IHTA 1984 s.18) applies at the first death — no IHT. At the second death, the trust capital is in the life tenant's estate under IHTA 1984 s.49(1).

Income tax for life interest trusts involves an interplay between the trustees and the life tenant: (1) TRUSTEES' INCOME TAX POSITION: the trustees receive the gross income of the trust and pay income tax: (a) savings income (bank interest): trustees pay income tax at the standard rate (20%); (b) dividends: trustees pay income tax at the dividend trust rate (7.5% until 2023; now the dividend basic rate of 8.75%); (c) rental income and other income: trustees pay income tax at the standard rate (20%). However, for a qualifying IIP trust, the income is NOT accumulated by the trustees — it belongs to the life tenant. The trustees pay income tax at the basic rates only; (2) THE LIFE TENANT IS TREATED AS RECEIVING THE INCOME: the life tenant is treated as the beneficial recipient of the trust income (ITTOIA 2005 Part 5, Chapter 7). The life tenant's total income includes the trust income. The trustees account for tax at 20% (or dividend rates) and pay over the net income to the life tenant. The life tenant then: (a) if they are a non-taxpayer or basic rate taxpayer: the trustees have paid enough tax on their behalf — no further liability; (b) if they are a higher rate taxpayer (40%): the life tenant owes an additional 20% on top of the 20% already paid by the trustees; (c) if they are an additional rate taxpayer (45%): the life tenant owes an additional 25%; (3) SELF-ASSESSMENT: the life tenant must declare trust income on their annual self-assessment tax return. The trustees will provide a form R185 (trust income) showing the gross amount and the tax withheld. The life tenant uses this to complete their return; (4) PERSONAL ALLOWANCE: the life tenant can use their own personal income tax allowance (£12,570 in 2025/26) against trust income (and all other income). If their only income is trust income and it is below the personal allowance, the life tenant can reclaim the tax paid by the trustees. This is common for retired beneficiaries with modest trust income below the personal allowance; (5) DIVIDEND CREDIT: prior to April 2016, dividends carried a 10% tax credit. That credit system was abolished — dividends are now received as 'actual dividends' and the dividend allowance (£500 in 2025/26) provides partial relief.

CGT within a life interest trust is charged on the trustees — not the life tenant — when trust assets are disposed of: (1) TRUSTEES' CGT POSITION: the trustees of an IIP trust are assessed for CGT on gains arising from disposals of trust assets (sales, gifts, exchanges). The gain is calculated as the proceeds (or market value) less the base cost. The base cost is: (a) the probate value if the asset was acquired via a will (death); (b) the settlor's original cost if settled by a lifetime settlement (unless the settlement was a gift on which hold-over relief was claimed); (2) ANNUAL EXEMPT AMOUNT FOR TRUSTS: the trust's annual exempt amount is currently £1,500 (reduced significantly from £3,000 and the former £12,300). If the trustees' total gains in a tax year exceed £1,500, CGT is payable on the excess; (3) CGT RATES FOR TRUSTEES: trustees pay CGT at the trust rate: 20% on most assets; 24% on residential property (from 6 April 2024). Trustees do not benefit from the 10% or 18% lower rates available to individuals; (4) HOLD-OVER RELIEF (TCGA 1992 s.260): when a trustee disposes of an asset by way of gift or settlement (e.g. advancing capital to the life tenant or remainderman), hold-over relief may be available (if it is a chargeable transfer for IHT or the trust is a relevant property trust). This defers CGT; (5) WHEN THE LIFE TENANT OCCUPIES TRUST PROPERTY — PPR: where the trust holds a dwelling house and the life tenant occupies it as their main residence, principal private residence (PPR) relief is available on the trustees' disposal of the property. The trustees do not pay CGT on the gain attributable to the life tenant's period of occupation as their main home (TCGA 1992 s.225); (6) ON THE DEATH OF THE LIFE TENANT — CGT UPLIFT: when the life tenant dies, the trust assets are treated as disposed of at market value under TCGA 1992 s.73. Importantly, this is a 'deemed disposal' for accounting purposes but does NOT give rise to an actual CGT charge — the assets are treated as reacquired at market value. The remaindermen inherit the assets at their value at the date of the life tenant's death (the new base cost for any future CGT calculation).

The life interest can end in several ways — each with different tax consequences: (1) TERMINATION BY DEATH OF THE LIFE TENANT: when the life tenant dies, the trust fund passes to the remaindermen. (a) IHT: the trust capital is treated as part of the life tenant's estate (IHTA 1984 s.49(1)) and IHT is charged accordingly. The life tenant's NRB (and TNRB) are applied against their combined estate (own assets + trust capital). RNRB may be available if the trust contains a qualifying residential property passing to direct descendants. IHT is paid from the trust fund or the estate as agreed between trustees and executors; (b) CGT: no CGT charge arises on the death itself (TCGA 1992 s.73 — CGT uplift); the remaindermen inherit the assets at their value at the date of death; (2) EARLY TERMINATION — SURRENDER BY THE LIFE TENANT: if the life tenant voluntarily surrenders (gives up) their life interest before death, this is a disposal for IHT purposes. Under IHTA 1984 s.52: (a) if the surrender is for consideration — it may be a chargeable transfer; (b) if the surrender is to an immediate successor who takes absolutely — it is treated as a PET (if the settled property now passes absolutely to an individual) or a chargeable transfer (if it falls into the relevant property regime). For qualifying IIP trusts, surrender passes the benefit to the next person, and IHTA s.52 applies; (3) VARIATION OF THE TRUST — TSI: if the trust is varied so that one beneficiary's life interest passes to another beneficiary, this may qualify as a 'transitional serial interest' under IHTA s.49C — provided the original life interest was either a pre-2006 qualifying IIP or an IPDI. The TSI rules grandfather the IHT treatment; (4) POWER OF ADVANCEMENT: trustees may have a power to advance capital to the life tenant (TA 1925 s.32 — advance up to one-half of the presumptive share of capital to a beneficiary with a vested interest in capital). Advancement is a distribution of capital — it reduces the trust fund. For IHT, an advancement from a qualifying IIP reduces the life tenant's deemed estate; (5) ENDING THE TRUST: when the remaindermen become entitled to the trust fund (on the death of the life tenant or the end of the life interest period), the trust comes to an end. The trustees transfer the assets to the remaindermen. The transfer is effected by a formal deed of appointment and an assent or transfer of the assets. Final trust accounts are prepared and the trust files its last tax returns.