If a property is owned jointly, it is worth evaluating whether a life interest trust should be established upon the death of the first joint owner. Normally, this would be stated in your will. This note describes how to do so using a life interest trust in your will, as well as the advantages and disadvantages. We’ll also look at how the flexible life interest trust affects your inheritance tax payments.
What is a Life Interest Trust?
A life interest trust contained in a Will is a legal entity that allows assets belonging to the deceased to be deposited into the trust for the benefit of a particular individual, usually the surviving spouse, known as the ‘life tenant.’ The life tenant is only entitled to the trust’s income, while the underlying capital assets are held for the benefit of the remaindermen — those who will eventually inherit the assets once the life tenant no longer requires the benefit of the income. Income in a life interest trust is often any interest or dividends created by capital cash invested or the right to immediate use and enjoyment of any property under the trust, which includes continuing to reside in the family home.
The trust can be set up to allow the surviving spouse to profit from the trust assets for the rest of their lives, or the survivor’s rights can be limited by including certain trigger points in the trust deed that have the effect of terminating the survivor’s rights. Re-marriage or permanently leaving the property to live elsewhere, such as in a care facility, are typical trigger points.
Types of Assets Often Included in the Life Interest Trust
The trust’s assets can be real property, cash, investments, or a combination of these. When a property is placed in a trust, the life tenant has the right to live there until they die.
What is a ‘Flexible Life Interest Trust’?
A flexible life interest trust is a type of life interest trust in which you provide additional specifics about what happens to your possessions. You can ensure that the life tenant receives funds from the estate, which are then recalled from their part of the property and repaid to the trust fund after their death.
Flexible life interest trusts are especially beneficial in households where the husband or wife has children from a prior marriage. When you create a flexible interest life trust, you should prepare an expression of desire letter to let the trustees know what you want to happen.
What are the Advantages of a Life Interest Trust?
#1. Controlling the assets’ eventual destination
While ensuring that a life tenant is cared for for the remainder of their life, the capital value of the fund is ultimately protected for the beneficiaries who you want to receive the assets in the long run, such as your children. For example, if the surviving spouse remarries, your estate would be shielded from the influence of another spouse, and your assets would revert to your children when your spouse died.
#2. Bankruptcy of the life tenant
Because the life tenant is solely entitled to the trust’s income, the capital worth of the fund cannot be considered by a Trustee in Bankruptcy in the event that such an order is made.
#3. Asset Protection from Care Home Fees
A life interest trust essentially ring-fences the assets within the trust, preventing them from being considered if the survivor needs residential or nursing care in the future. Depending on the conditions of the trust, the income from the fund could be used to help pay for any costs for the life tenant, but the capital fund would stay undisturbed. Alternatively, the trust may stipulate that the survivor’s claim to any benefit from the property terminates when the surviving permanently leaves the property.
#4. The transferable nil-rate allowance for Inheritance Tax is still in effect.
A life interest trust that benefits a spouse or civil partner qualifies as an absolute gift, allowing the nil rate band to be transferred for Inheritance Tax purposes. There would be no inheritance tax to pay on the assets moving into the life interest trust under present legislation if the life tenant is the surviving spouse/civil partner. This does not apply if the life tenant is an unmarried partner.
What are the Disadvantages of a Life Interest Trust?
#1. Inadequate Control
A life interest trust means that any assets left in this manner are not made as an absolute gift to the surviving spouse. Because the survivor is only entitled to the income from the trust or the right to remain in the property, they may feel defenceless and as if they have no control over the assets.
#2. The trust’s rigidity
A trust can be perceived as rather rigid at times, and some spouses detest having to answer to trustees. If the remaindermen are under the age of 18, it might be very difficult to change trust in any way. However, it is feasible to incorporate powers in the trust that can be expanded to allow the Trustees to advance money to the survivor if necessary, while the survivor has no absolute right to anticipate this.
#3. Additional formalities to cope with
There are additional formalities involved in administering the trust, as well as specific procedures that must be followed when setting up investments and dealing with property. As with anything, these disadvantages must be considered against the advantages of having trust in each unique circumstance.
What must be done to ensure that the Life Interest Trust in the Will is Effective?
If you opt to put your whole inheritance in a life interest trust, it is prudent to assess the amount of your assets and how they are held to maintain as much parity as possible between a couple, as there is no way of knowing who will die first. Consider the assets to be transferred to the trust upon the death of the first of you to guarantee that the surviving spouse has enough assets to live on as much as possible.
If you own your home jointly and wish to leave it in a life interest trust, you must verify that it is held as tenants in common, so that each spouse owns a definite share of the property. This share then becomes part of the estate going under the Will and can pass into the trust. To accomplish this, it may be necessary to file a Notice of Severance.
You would also need to decide when you want the survivor’s entitlement to benefit from your portion of the property to end, e.g., on death or when they permanently leave the property, whichever comes first. If you intend to incorporate cash assets in the trust instead of or in addition to property, it is prudent to equalise your cash assets as described above.
What are the Tax Implications of a Life Interest Trust?
Some people create life interest trust wills for tax considerations, particularly inheritance tax purposes. However, whether or not this is effective is dependent on how the trust is written.
Inheritance Tax
Normally, inheritance tax is not due on the assets of a life interest trust when a beneficiary dies. In general, moving an asset into a trust on death will result in IHT. If the amount of the assets passing to beneficiaries, plus any gifts made by the settlor in the seven years preceding their death, is less than £325,000, inheritance tax will not be due.
If the life tenant is a surviving spouse, IHT is not payable on the assets in the property trust. During the trust’s lifetime, the life tenant is considered to be entitled to the capital, thus when they pay, it is handled as if they are transferring monies to the beneficiaries.
Capital Gains Tax
If the trustee’s yearly exemption is exceeded, he or she must pay capital gains tax at a rate of 20%.
Income Tax
Trustees must normally pay income tax at the standard rate of 20%, but just 7.5 percent on dividends received. If the life renter is not required to pay tax, they may be able to recoup it. The tax treatment is determined by their nil rate band.
Who should be the Trustees of the Life Interest Trust?
It is entirely up to you who you appoint as trustees, but you must appoint at least two individuals whom you trust to care about the trust’s ultimate purposes, especially to provide an income for the survivor and to ensure that the capital is eventually given to the named beneficiaries.
In many circumstances, the surviving spouse, together with one or two other family members or friends, is designated as a trustee to ensure that they are included in any decisions and that their opinions are respected. It is permitted to appoint those who would ultimately benefit, such as your children. In some cases, appointing independent trustees may be appropriate to ensure that all decisions are made in the best interests of the beneficiaries with no hidden intentions or conflicts of interest. Any professional trustee would charge for their services, which would have to be deducted from the trust money.
How will the trust be established in the event of death?
The procedure taken to form the trust upon your death will be determined by the assets to be placed in the Trust. Any monetary assets must be invested in the names of the trustees, and any property must be transferred into the joint names of the appointed trustees and the surviving spouse (in cases where they already own a share in the property).
What types of investments can the trustees make?
The trustees have a wide range of legal investment rights, and they have a duty of care to their beneficiaries to ensure that they exercise reasonable caution when handling any aspect of trust administration or investment.
Beneficiaries may claim a breach of trust if they do not take reasonable care. Trustees of a full life interest trust should diversify any investments to ensure a balance between the competing requirements of the surviving spouse, who is entitled to income only, and the ultimate beneficiaries, who would receive capital.
This can be challenging when there is a pressing need to collect the maximum income for the surviving spouse, thus, it is critical that the powers of a trustee have been carefully considered when the Will is created. It is feasible to include additional powers that allow trustees to advance capital cash to the surviving spouse if necessary.
Life Interest Trust FAQs
Who pays tax on a life interest trust?
We propose appointing a maximum of four trustees and a minimum of two. The trustees are in charge of declaring and paying income tax and capital gains tax. The income received belongs to the life renter and is taxed at the same rate as their personal income tax. The trust is subject to capital gains tax.
Can you change a life interest trust?
It has no effect until you die because it is a Will Trust. This implies you’re not making any gifts right now, but you can change your mind later if you like. It can also be changed ahead of your death if there are any future changes in legislation that would influence how it works.
What is a life tenant entitled to as well as income?
A life tenant is entitled to a fund’s income but not its capital. The entitlement is normally for life, however, it can be for a shorter amount of time. A widow, for example, may have a life estate interest in her late husband’s estate until she remarries.
Do you have to register a life interest trust?
When the life tenant dies, the beneficiaries of the trust become absolute owners of the trust property. Because the trustees are responsible for paying any tax on the trust property, these trusts may also be required to register.
