UK Interest in Possession Trusts: Tax Treatment in 2026

An Interest in Possession (IIP) trust is a type of trust where the beneficiary -- known as the life tenant -- has the immediate right to receive income from the trust as it arises. This distinguishes it from a discretionary trust, where trustees decide who receives income. Understanding how IIP trusts are taxed is essential for anyone involved in estate planning, family wealth protection, or administering a deceased estate.

What Is an Interest in Possession Trust?

An IIP trust is a legal arrangement where:

• The life tenant is entitled to receive all income produced by the trust assets as it arises
• The remaindermen (or capital beneficiaries) are entitled to the underlying capital after the life interest ends -- typically on the life tenant's death
• The trustees manage the assets and are legally obliged to pay income to the life tenant

The defining feature is that the life tenant has a present entitlement to income. Trustees cannot accumulate income or redirect it to other beneficiaries. This is why IIP trusts are also called "fixed interest trusts."

Common examples include a will trust where a deceased person leaves assets in trust for a surviving spouse (as life tenant) with the remainder passing to children on the spouse's death.

Income Tax: How It Works

Tax at the Trustee Level

Trustees of an IIP trust pay income tax on the trust's income at basic rates:

• Non-savings income (rental income, trading income): 20%
• Savings income (interest): 20%
• Dividend income: 8.75% (the basic rate for dividends)

Note that IIP trusts do not pay tax at the trust rate (45%) or the dividend trust rate (39.35%) that applies to discretionary trusts. This is a significant difference.

Tax at the Life Tenant Level

The life tenant must include their share of the trust income in their own self assessment tax return. They receive a credit for the tax already paid by the trustees. The position then depends on the life tenant's own tax rate:

• Basic rate taxpayer: No further tax is due. The trustees' 20% payment covers the basic rate liability in full.
• Higher rate taxpayer (40%): The life tenant pays an additional 20% on non-savings income, bringing total tax to 40%.
• Additional rate taxpayer (45%): The life tenant pays an additional 25% on non-savings income.
• On dividends: The 8.75% paid by trustees covers the basic rate. Higher rate taxpayers pay an additional 25% (total 33.75%). Additional rate taxpayers pay an additional 30.6% (total 39.35%).

If the life tenant is a non-taxpayer (for example, their income falls within the personal allowance of £12,570), they can reclaim the tax paid by the trustees from HMRC.

The Tax Pool

Trustees must maintain a tax pool -- a record of all income tax paid by the trust. When income is distributed to the life tenant along with a tax credit, the tax pool must have sufficient funds to cover the credit. If it does not, additional tax is payable by the trustees. This is less of an issue for IIP trusts than for discretionary trusts, since trustees pay at basic rates.

Capital Gains Tax for IIP Trusts

CGT Rate for Trustees

When trustees of an IIP trust dispose of trust assets, they pay CGT at:

• 20% on most assets (shares, investments)
• 24% on residential property (2026/27 rate)

Note: the 2026/27 CGT rates apply from 6 April 2026.

Annual Exempt Amount

Each trust has its own CGT annual exempt amount, but for 2026/27 it is set at £1,500 -- half the individual allowance of £3,000. If a settlor has created multiple trusts, the annual exempt amount is divided between them (subject to a minimum of £300 per trust).

Hold-Over Relief

Trustees of IIP trusts can claim hold-over relief when transferring assets to the life tenant or to remaindermen on the ending of the life interest. Hold-over relief allows gains to be deferred, with the recipient taking the asset at the original cost base.

However, there is an important restriction: hold-over relief for transfers into trust at the outset is generally not available for IIP trusts created after 21 March 2006 (unless they qualify as a disabled person's interest or an immediate post-death interest).

Inheritance Tax: The Critical Feature of IIP Trusts

Why IIP Trust Assets Are in the Life Tenant's Estate

This is the most significant IHT feature of IIP trusts. Unlike discretionary trusts (which fall under the "relevant property regime" with 10-year anniversary charges and exit charges), a qualifying IIP means the life tenant is treated as beneficially entitled to the underlying capital.

Specifically, HMRC treats the life tenant as owning the trust property for IHT purposes under IHTA 1984, s.49. The practical result: when the life tenant dies, their estate includes both their own assets and the trust fund.

Qualifying Interest in Possession

For this IHT treatment to apply, the trust must be a "qualifying interest in possession" (QIIP). A QIIP is:

• An IIP that existed before 22 March 2006 (the date of the major trust tax reform)
• An immediate post-death interest (IPDI) -- an IIP arising from a will or intestacy on or after 22 March 2006
• A disabled person's interest
• A transitional serial interest (certain situations where one IIP replaces another)

An IPDI is the most common modern form. When someone dies and leaves assets in trust for a surviving spouse for life, with children as remaindermen, the spouse's interest will typically be an IPDI and will form part of the spouse's estate on their death.

Spousal Exemption for IPDIs

Crucially, if the life tenant of an IPDI is the deceased's spouse or civil partner, the assets passing into the trust qualify for the unlimited spousal exemption on the first death. This means no IHT is due when assets pass into the IPDI trust on the first death, even if the trust fund exceeds the nil rate band.

On the surviving spouse's death, the full trust fund is included in their estate -- but they will also benefit from the transferable nil rate band from the first spouse's death (potentially £650,000 combined nil rate band plus residence nil rate band).

IIP Trusts vs Discretionary Trusts

The IHT treatment differs fundamentally between these two trust types:

IIP trust (QIIP): Assets are in the life tenant's estate. IHT is paid on death. No 10-year charges or exit charges on the trust fund itself.

Discretionary trust: Falls under the relevant property regime. A 6% charge applies every 10 years (the anniversary charge), calculated on the trust's value above the nil rate band. An exit charge also applies when capital leaves the trust. No assets are in any individual beneficiary's estate.

For many family situations -- particularly protecting a family home for a surviving spouse -- an IIP trust is the simpler and often more tax-efficient structure.

Practical Uses of IIP Trusts

Protecting a family home: A couple can leave their share of the family home on IIP trust for the surviving spouse, ensuring the survivor can live there for life while protecting the children's eventual inheritance.

Income provision for a surviving spouse: Trust assets generate income which passes to the surviving spouse. On death, capital passes to children.

Vulnerable beneficiaries: Trusts for disabled individuals can qualify as a disabled person's interest, a type of IIP with beneficial tax treatment.

Life insurance policies: Writing a life insurance policy into a specially worded trust can avoid IHT, though care is needed about whether the trust creates an IIP.

Frequently Asked Questions

What is the difference between a life tenant and a remainderman in an IIP trust? The life tenant has the current right to receive all income from the trust. The remainderman (or capital beneficiary) receives the underlying capital when the life interest ends, typically on the life tenant's death.

Do IIP trusts pay the 45% trust rate of income tax? No. IIP trustees pay income tax at basic rates -- 20% on non-savings income and savings income, and 8.75% on dividends. The higher trust rates (45% and 39.35%) apply to discretionary trusts, not IIP trusts.

Does the life tenant need to complete a self assessment tax return? If the life tenant receives trust income, they should declare it on a self assessment tax return and claim credit for the tax paid by trustees. If the trust is their only source of income, they may need to register for self assessment specifically for this purpose.

Are IIP trust assets subject to 10-year anniversary charges? No. IIP trusts (specifically QIIPs) are not subject to the relevant property regime. There are no 10-year anniversary charges or exit charges on the trust fund. The IHT exposure comes on the life tenant's death when the assets are treated as part of their estate.

What happens to the IIP trust when the life tenant dies? The life interest ends. The trust assets are included in the life tenant's estate for IHT purposes and taxed accordingly. The trustees then distribute the capital to the remaindermen as directed by the trust deed.

Can the life tenant give away their interest in the trust? The life tenant can assign or surrender their interest. This could have IHT implications -- for example, surrendering the interest to the remaindermen would be a potentially exempt transfer (PET) by the life tenant, which becomes exempt if the life tenant survives 7 years.

What is an Immediate Post-Death Interest (IPDI)? An IPDI is an IIP trust created by a will or arising on intestacy after 22 March 2006, where the life tenant is entitled to income immediately on the testator's death. IPDIs qualify as QIIPs and receive the same IHT treatment as pre-2006 IIP trusts.

What is the CGT annual exempt amount for an IIP trust? For 2026/27, the annual exempt amount for each trust is £1,500 -- half the individual exemption of £3,000. If a settlor has created more than one trust, the exempt amount is shared between them.

Can trustees accumulate income in an IIP trust? Generally no. The defining feature of an IIP trust is that the life tenant has an immediate entitlement to income as it arises. Trustees who accumulate income without good reason may be in breach of trust. Some trust deeds allow limited accumulation in specific circumstances.

Should I use an IIP trust or a discretionary trust for my will? This depends on your circumstances. If you want to protect assets for a surviving spouse while ensuring children eventually inherit, an IIP trust via will is commonly used and IHT-efficient due to the spousal exemption. Discretionary trusts offer more flexibility but face the relevant property regime charges. Take professional legal and tax advice for your specific situation.