What is a Life Interest Trust?
A life interest trust is a type of trust specified in your Will, allowing assets from a deceased individual to be placed into a trust for the benefit of another person, usually a spouse, known as “the Life Tenant.” The trustees of your will manage this trust during the lifetime of the Life Tenant. Upon their death, the trust ends, and the assets pass to the final beneficiaries, legally known as “the Remaindermen.”
This form of trust only becomes active upon your death, distinguishing it as a testamentary trust. The trustees hold the legal title to the assets for the benefit of the Remaindermen, following your precise instructions, unlike a discretionary trust where trustees have control over asset distribution.
What Assets Can Be Placed in the Trust?
There is no restriction on the types of assets you can place in a life interest trust. Common assets include property, cash, personal items and business interests. You have the flexibility to place your entire estate or just a portion of it into the trust, according to your preferences.
Why Do People Use Life Interest Trusts?
Life interest trusts are valuable tools in estate planning. They allow you to control the future of your property posthumously. The primary advantage is that the trust provides the life tenant with a home during their lifetime (a right to reside) and income from other estate assets, while the capital is reserved for the Remaindermen (often children). This arrangement is particularly beneficial if you have children from a previous relationship and want the capital value of your assets to go directly to them rather than your surviving spouse.
Additionally, a life interest trust can protect your assets from being used to cover your surviving spouse’s care costs. While currently, retaining a life interest in property is not considered a deprivation of capital for local authority care assessments, future legal developments might lead to more scrutiny of these arrangements.
Are There Any Disadvantages?
While advantageous for older individuals, life interest trusts might not suit younger couples. For many, their property is their largest asset. Placing it in a life interest trust restricts the life tenant’s access to the capital, possibly leading to financial hardship. There are also costs involved in setting up and managing the trust after your death.
Tax Implications of a Life Interest Trust
The tax consequences of a life interest trust depend on the trust clause’s wording and the included assets. There are three primary taxes to consider: inheritance tax, capital gains tax, and income tax.
- Inheritance Tax: Charged at 40% on amounts exceeding your nil rate band allowance (£325,000). If your estate includes a property left to a direct descendant, it qualifies for the residence nil rate band allowance (up to £175,000). Gifts between spouses are exempt, regardless of the estate’s value.
- Capital Gains Tax: Based on your income tax rate. For basic rate taxpayers, it is 20%, and for property, it is a flat 28%. Beneficiaries receive the asset at its value on the date of your death. If sold later for a higher value, they are taxed on the gain minus allowable costs and allowances.
- Income Tax: Charged on income-producing assets within the trust exceeding the annual tax-free amount (£500). The beneficiary pays the tax, which must be included in their annual tax return.
If the life tenant is a spouse, there are no inheritance tax implications until their death. After their passing, the respective shares of the property fall into individual estates, potentially triggering inheritance tax depending on the estate’s total value and available allowances or exemptions.
If the trust remains active for more than two years after your death, it must be registered with HMRC.
What Happens if the Life Tenant Wants to Move House?
If the life tenant wishes to downsize, they can use your share of the sales proceeds. Trustees must be involved in the sale and purchase of the new property, making the life tenant a co-owner alongside the trustees. Any surplus funds not used in the new purchase can be distributed to the Remaindermen.
Setting Up a Life Interest Trust
To set up an effective life interest trust, consider how you hold your property—either as joint tenants or tenants in common.
- Joint Tenants: You and your co-owner own 100% together. Upon one’s death, the property automatically passes to the survivor, regardless of the will’s contents. For a life interest trust to be effective, you must hold the property as tenants in common.
- Tenants in Common: You and your co-owner hold defined shares of the property (usually 50/50). Your share’s fate is dictated by your will.
If you hold the property as joint tenants, you will need to sever the tenancy and apply to the Land Registry to change the title deeds.
Conclusion
If you believe a life interest trust suits your family’s needs, contact our team at 02920 237777 to discuss your requirements and get the necessary legal advice.
