A ‘life interest trust’ also known as an interest in possession trust provides that one or more persons (the life tenant) will receive the income from the trust assets during their lifetime (or such other period as is specified). On the death of the life tenant the trust assets then pass to other named beneficiaries known as remaindermen.
A life interest is often created by will in respect of a property so that the life tenant may live in the property for the rest of their life, but the deceased’s share in the property will be owned by the trustees of the deceased’s will.
[If the property had been owned by the deceased and another (usually the surviving spouse), it will be necessary for the property to have been held as a tenancy in common so that the deceased’s share will pass under their will. If the property had been owned as joint tenants it would automatically pass to the surviving owner, who could sever the joint tenancy by a deed of variation, if they wish it to be treated as if it had been a tenancy in common as at the death.]
The trust will contain provisions as to terms of occupation of a property by the life tenant, who does not need to pay rent, but will have to insure and maintain the property etc. similar to a tenant under a tenancy agreement.
Such a trust usually provides flexibility in that if the life tenant wishes to move, the trust fund can be reinvested in an alternative property. If the life tenant wishes to downsize and there were surplus monies left over, these would be invested and the life tenant would have the benefit from any income produced. There may also be a power of advancement so that if there were spare funds, but these were needed by the life tenant, they could be passed onto the remaindermen with the life tenant’s agreement or sometimes at the discretion of the trustees.
The benefit of this type of trust is the protection it affords either because it is not thought appropriate for the life tenant to own the trust assets outright or because the deceased wishes to ensure that whilst the life tenant can enjoy the income of the trust assets, the capital will ultimately pass to other beneficiaries.
In the case of spouses it may be that the surviving spouse will require residential care, and if so only the share of the property which they own can be included in a means assessment; whilst the trust’s share should be protected as an inheritance for the couple’s family or respective beneficiaries.
From an inheritance tax (IHT) perspective, the creation of the trust is treated as a gift to the life tenant, even though they do not own the capital value absolutely. On the death of the life tenant the trust’s value will then be aggregated with the life tenant’s estate in order to calculate the tax payable. The tax will be divided between the life tenants’ estate and the trust on a pro rata basis and the trust’s share will be payable out of the trust fund before the balance is distributed to the remaindermen.
If the life tenant releases their interest during their lifetime it will be a potentially exempt transfer (PET) and IHT may be avoided if the life tenant survives the release by seven years.
The income (if any) can be mandated to the life tenant, in which case the life tenant will report the income and pay income tax according to their personal rate, not that of the trustees. Any capital gains made on the trust assets will have the benefit of the Trustees’ annual allowance, which is half of a single person’s allowance, and beyond that will be subject to capital gains tax at the trustees’ rate. This is unlikely to be an issue if the life tenant occupies a property owned by the trust as the trustees may claim the life tenant’s Private Residence Relief.
The trust will need to be registered on the trust registration service.
Trustees should review the trust assets – at least annually if they are in investments and from time to time if the only asset is a property occupied by the life tenant. They need to consider whether the trust is meeting the needs of the beneficiaries. Accounts should be kept as well as records of any decisions made, such as, changes to the trust assets.
If all beneficiaries are adults, mentally capable and in agreement then there are ways in which the trust may be terminated before the death of the life tenant.
For more detailed information as to the creation, administration, including registration or termination of such a trust please contact a member of W. Davies’s Personal Legal Services Department.
