Advisers looking for an Inheritance Tax (IHT) efficient trust solution that maintains flexible access for the settlor post creation.
A carve out trust separates different interests or rights, some of which are held absolutely for the settlor of the trust and some of which are held for the beneficiaries (excluding the settlor).
Under a carve-out trust the gift with reservation of benefit rules do not apply, because the settlor is specifically excluded from benefiting from the rights held for beneficiaries.
The interests or rights held for the settlor are not regarded as ‘settled property’ under the IHT definition [IHTA 1984 s43] and therefore are not subject to the relevant property regime, where exit charges and 10-year charges would apply.
Carve-out trusts are not new, and HMRC are fully aware of the mechanics of these types of trust. The existence of carve-outs have been challenged in court, an example being Ingram v Inland Revenue where the executors of Lady Ingram successfully argued the existence of a carve-out (a lease) which avoided the reservation of benefit rules applying [Finance Act 1986 s102].
When the Pre-owned asset tax was introduced in 2005, the fact the mechanics of a carve-out trust exclude the settlor from benefiting from the settlement – meant the POAT charge did not apply to these types of trust. Also in more recent developments, the Disclosure of Tax Avoidance Schemes (DOTAS) consultation lists such schemes as excepted from disclosure.
The Lifestyle Trust, launched early 2016, is written as a ‘carve-out trust’ where the trust ‘carves-out’ the right for the settlor to access ‘Policy Funds’ at certain dates in the future.
The access is defined at outset within the trust deed – referred to as an entitlement schedule. The settlor states how many policies within the bond they require on each bond anniversary date, for example 100 policies a year for 10 years. Each access ‘group’ would be allocated a Policy Fund letter, A, B, C, D etc.
The settlor can request that the trustees defer or waive a Policy Fund if it is decided that access is no longer required at the specified anniversary.
Carve-out trusts like the Lifestyle Trust, rely on the valuation principles under IHTA 1984 s160 – ‘the price which the property might reasonably be expected to fetch if sold in the open market at that time’ - to value what is subject to IHT when the trust is setup and any ongoing IHT charges. This is described in more detail below.
As described above, the Lifestyle Trust allows the settlor to specify access to certain Policy Funds (groups of individual policies within an investment bond) at future dates. The rest of the trust fund is held on discretionary trust for certain classes of beneficiaries including children, grandchildren etc.
The value of the gift into the discretionary trust is the premium paid to the investment bond (net of any adviser fees) minus the value of the benefit carved out. The value of the right to the Policy Funds is based on what a purchaser would pay on the open market if sold. So the question is ‘what would you pay for access to Policy Funds at a future date?’
If we look at two key considerations here:
The first one is in effect the position of a DGT however, as the trustees have the overriding power to appoint benefits out of the trust fund then the value of that entitlement is negligible as this appointment could defeat the benefit carved out. This leads to no discount to the gift into the Lifestyle Trust.
As the Policy Funds are carved out absolutely at commencement they are not included within the settlement (the discretionary trust) for Inheritance Tax purposes and are therefore outside the scope of the GWR provisions.
The Policy Fund carved out for the vesting date in question now has a value (that of the policies contained within the Policy Fund). This value is now in the estate of the settlor as it is held on trust for them absolutely (a bare trust). This is not an exit from the discretionary trust as the carved out access to the trust fund never formed part of the settlement (as described above) so no exit charge will apply.
The trustees can then:
The settlor can defer the date they can access a Policy Fund as long as this is done prior to the vesting date outlined in the original trust deed (or a date changed in a previous deferral).
The deferral is a loss to the estate. However, the same valuation principle applies as at inception. As the Policy Fund has no market value prior to a vesting date the loss to the estate and therefore transfer of value is negligible.
Trustees have a duty of care to beneficiaries to act fairly between them, to consider their interests and needs, to ensure trustees interests do not conflict with those of the beneficiaries and to provide information and accounts to them upon request.
The settlor has an absolute right to the Policy Funds under the trust once the vesting date is met – this is the purpose of the carve-out. Therefore, at outset when the trustees are appointed the Trust Fund consists of the trust property less the carved out property. The settlor is not a beneficiary under the discretionary trust.
The trustees should give consideration to the settlor’s rights, and examples of this are that the settlor’s consent should be received by the trustees before surrendering the bond, or before income tax is paid from the bond – as that could fetter the settlor’s rights.
Carve-out trusts appear in numerous forms; this includes DGTs, flexible reversionary trusts and split trusts for critical illness and life assurance policies. There is a long history associated with these so advisers should feel confident in their acceptance by HMRC.
Last updated: April 2026
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The information provided in this article is not intended to offer advice.
It is based on Quilter's interpretation of the relevant law and is correct at the date shown. While we believe this interpretation to be correct, we cannot guarantee it. Quilter cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.
