Interest in possession trusts

Interest in possession trusts

This page was last updated on 1 November 2020

Interest In Possession Trust

In this article, we talk about the benefits of an interest in possession trusts.

Topics that you will find covered on this page

What is an interest in possession trust?

This is a trust where the trustee must give all the trust income to a beneficiary as the income is generated, except for trust expenses.

A different beneficiary is entitled to the possessions capital in the trust fund.  The beneficiary who is meant to get the trust income is the life tenant/income beneficiary. The beneficiary who is entitled to the actual capital in the trust is called either the remainderman or the capital beneficiary.

An interest in possession trust can be a lifetime trust or the conditions establishing the trust can be in the person’s will.

How do interest in possession trusts work?

Interest in possession trusts have two different types of beneficiary, the beneficiary who gets the income of the trust, and one who will actually get the asset and investments in the trust. This is best explained through an example:

Example:

A’s will establishes a trust fund containing all of her shares.

The dividends earned from the trust go to A’s husband, B. When B dies, the shares will pass onto A and B’s children who will get the shares themselves.

B, therefore, is the life tenant/income beneficiary, so gets access to the share income. However, B has no rights to the actual shares.

When B dies, the trust arrangement will end, and the children will get all the trust assets.

Here is a short video that defines what an interest in possession trust is.

What is the purpose of an interest in possession trust?

This type of trust is useful for anyone considering how to handle their estate.

It is especially useful for spouses and civil partners, as when after the death of one person, the surviving spouse can continue to live in the family home, but the children are still entitled to the trust funds when the surviving spouse dies.

There can be other benefits, such as to do with care costs evaluation of assets.

Before the changes in tax rules on the 22nd of March, these life interest trust arrangements were useful for life policies, as the inheritance from trust was taxed less. However, the tax rates are now higher so this is less useful.

If the trust arrangement is set out as a deed in your will, you can still use the asset as you please while you are alive.

You can also change the details in your will to reflect who you want to benefit from the money and assets. For lifetime trusts, the settlor is likely to be one of the trustees, so they have the power to determine what happens with their assets and investment.

The trustees as a team can change who is a beneficiary and what assets and property are part of the trust.

Is an interest in possession trust a type of discretionary trust?

An interest in possession trust is different from a discretionary trust because the trustees do not have control over how the assets are distributed.

However, for trust inheritance tax, life interest trusts are treated like discretionary trusts.

What taxes do you have to pay on an interest in possession trust?

To find out what taxes will apply, especially interest in possession trust inheritance tax. It is worth seeking legal help and advice.

Income Tax

The trustees have to pay income tax for an iip trust. Trustees can choose to either pay the income of the trust directly to the beneficiaries or pay them via the trusts funds. If the trustee pays the beneficiary directly, they will not need to put this in the trust tax return, however, they cannot deduct expenses from the trust income.

Where trustees do not pay the beneficiaries directly, income tax is payable at the basic rate. Dividend income is charged at 7.5%, all other income is charged at 20%.

The life tenant is entitled to the income after tax, and are charged at their own rate, considering their basic rate and personal allowance.

Capital Gains Tax

Capital gains tax (CGT) is payable on the profits earned by the trust.

Trustees have to pay capital gains tax on any amount over the annual exempt amount. The beneficiaries do not have to pay this type of tax on inheritance from a trust.

Inheritance Tax

How the trust is treated in terms of inheritance tax depends on whether it was set up while the person was alive or in their will.

Where the inheritance trust was set up during the person’s lifetime, it is important to consider whether the trust was set up before or after 22 March 2006.

"Interest in possession trusts have two different types of beneficiary, the beneficiary who gets the income of the trust, and one who will actually get the asset and investments in the trust."

How is an interest in possession trust created by will treated in terms of inheritance tax?

These trusts are often called immediate post-death interest or IPDI.

Inheritance tax will be due where the assets are transferred unless it is for a spouse or civil partner.

This type of trust is not seen as within the person’s estate. Therefore, 10-year charges and exit charges are not payable.

The value of the trust fund will be included in the life tenant’s estate after their death, so this will be taxed as per the normal tax regime.

How are lifetime interest in possession trusts before 22 March 2006 taxed?

Gifts into trust funds before this date were exempt transfers, so there was no tax charge for putting the money into the fund.

Therefore the trustees would not have to pay any tax unless the settlor died under 7 years after setting up the trust.

Also, trusts set up before the legislation changes on the 22nd of March 2006 did not have to pay the 10-year charge or exit charges.

These trusts were considered to come within the beneficiary’s estate. Since 6 October 2008, if a beneficiary of one of these trusts is changed, then the trust will come within the new regime, so is taxed just like a discretionary trust.

How are lifetime interest in possession trusts after 22 March 2006 taxed?

Lifetime trusts are taxed just like discretionary trusts.

Lifetime gifts into the trust fund have to pay 20% tax if they are above the settlor’s nil-rate band. Further, the ten-year charge applies, so 6% will have to be paid over the nil rate band. Further, exit charges will also be payable.

What is the 10-year charge on trusts?

One way money in a lifetime trust is charged inheritance tax is through periodic payments. On the trust’s ten year anniversary, there is an inheritance tax charge of 6%.

What is a qualifying interest in possession?

A qualifying interest in possession means that for inheritance tax purposes, the trust property is treated as though it belongs to the life tenant.

Therefore they are not taxed according to the relevant property regime, i.e. as though they are discretionary trusts.

Qualifying interest in possession trusts include:

  • Possession trust the income beneficiary became entitled to before 22nd March 2006
  • A trust the person became entitled to after 22nd March and that either: interest in the trust is only post-death, the interest is for a disabled person, or it is a transitional serial interest.

Would you like some help setting up a Trust or to have a free consultation on which Trust option is likely to be best for your circumstances?

You can contact us in one of 3 ways:

  • book an appointment directly in the calendar below, and one of the team will call you back at the chosen time
  • leave your contact details and we will get in touch with you
  • call us directly on 01442 953 901

Leave your details below and a Trust and asset protection specialist will get in touch

smarthpone-user

OR 

you can call us directly Monday – Friday between 9:00am – 5:00pm

Or

All calls are undertaken by Quadrant Estate Planning, one of the UK’s leading Trust and later life planning specialists.

Learn about different types of Trusts that could also help you

Property Protection Trusts

This is a trust you put in your will so that the surviving spouse can continue living in your property, but the deceased’s share of the property is kept separate.

Interest in Possession Trusts

This is a trust where the trustee must give all the trust income to a beneficiary as the income is generated, except for trust expenses.

Inheritance Tax Planning Trusts

By putting your money and property into a trust, you can maximize your tax-free allowance and reduce the amount of inheritance tax you pay.

Life Interest Trusts

A life interest trust is a trust written into a will. This means that the trustees hold the assets in the trust on behalf of the beneficiaries. Read more about them.

Asset Protection Trusts

The benefits can include reducing the care fees payable to the local authority and have tax advantages. 

Home Protection Trusts

Protecting assets in a trust is a good option for wealth management and getting control over who inherits from your estate.

Inheritance Protection Trusts

The term ‘inheritance protection trust’ could describe many different types of beneficiary trusts. However, it usually refers to a trust for healthy, capable beneficiaries in a will.

Family Protection Trusts

A family protection trust is a method you can use to ring-fence your assets from taxation, care fees, and other risks to your estate. 

Estate Planning & Trusts

Estate planning involves considering what to do with a person’s money and assets after they are deceased.

Share on facebook
Share on twitter
Share on email
Share on linkedin