Is any Inheritance Tax due if a default beneficiary dies? (IIP Trust)
Under an interest in possession, power of appointment trust, in the event of the death of a default beneficiary their share of the trust proceeds would count as part of their estate.
This means that if the deceased default beneficiary's total personal estate, including the value of their share of any life insurance policies in trust, exceeded the 'nil-rate band', then an Inheritance Tax liability could theoretically arise.
However, assuming the life policy or policies are some form of term insurance, which normally have no surrender or encashment value, then unless the insured person is in gravely poor health, or dies at the same time as the default beneficiary, there will be no potential liability to Inheritance Tax arising upon the death of a default beneficiary, as the policy would have a 'nil' value.
This means the amount included in the deceased default beneficiary's estate from the insured person's policy would be zero. A transfer of zero value does not give rise to any Inheritance Tax.
Even if the policy has a value, either because the insured person is in gravely poor health, or in the event that the insured person has died, either before or simultaneously with a default beneficiary, then under the 'spouse exemption' (see the relevant section) if the trustees appoint the benefits of a deceased default beneficiary to the (UK domiciled) legally-married spouse of the insured person, there will be no liability to Inheritance Tax.
Assuming that the insured person is alive and well, and that the policy therefore has a 'nil' value for Inheritance Tax purposes, and in the event of the death of one or more of the default beneficiaries, the trustees can appoint a new default beneficiary or can change the percentage to which the remaining existing default beneficiaries are 'beneficially entitled' without giving rise to any immediate Inheritance Tax liability.
However, any such changes to the default beneficiaries would bring the taxation of an Interest in Possession, Power of Appointment Trust into the post 22 March 2006 discretionary trust taxation.
