This page was last updated on 1 November 2020.
Life Interest Trust
This article explains the key aspects of a life interest trust.
Topics that you will find covered on this page
What is a life interest trust?
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.
Life interest trust wills are special because there are two types of beneficiaries. The ‘life tenant’ gets a life interest in the property, so can cont. Then there are the ‘remaindermen’, who get the property once the trust arrangement ends.
Why do people use life interest trusts?
Life interest trusts are useful for estate planning. One of the main life interest trust advantages is that you can leave your property, most commonly the family home, to your children, but allow your spouse to live in it for the duration of their life.
Here is a short video about life interest trust.
What type of trust is a life interest in property trust?
A life interest in property trust is a form of a testamentary trust, which just means it is set up in a will once you have passed away. This is a bare trust arrangement, as the trustee does not get to make a decision on how trust funds are distributed.
This type of trust is different from discretionary trusts, where the trustees have control over how the trust property is distributed. However, there can be a trust set up where the trust converts to a discretionary trust after the life tenant dies.
Life interest trusts are also different from lifetime trusts.
A lifetime trust comes into effect while the settlor is alive, and there can be trust income for the beneficiaries. Lifetime trusts are often used to avoid inheritance tax and care fees for the settlor, however, you need a lawyer to advise on this, as the law can be very complicated.
Who are life interest trusts for?
Life interest trusts are good for anyone who wants to protect their children’s inheritance of their share of the family home.
They are best for couples who are married or in a civil partnership, who want to protect their assets for their beneficiaries, but also leave the surviving spouse with a life interest in the property. The share in the family home can be diminished where the surviving spouse remarries or requires care home fees.
Life interest trusts prevent the risk of making a transfer of your property directly to your children.
This is because your children may not protect your spouse or civil partner’s rights to remain in the home. Further, your assets could be used if they file for bankruptcy or get divorced.
How do I go about creating a life interest trust?
Life interest trusts have to be set up in a will. This is a complicated process and can have unintended tax implications, so it is important to get help and advice from a solicitor.
Spouses and civil partners will have to make sure they both have this arrangement in their wills.
What is an example of a life interest will?
For example, Mrs. A and Mr. A are married, they want to ensure their family members, especially their children Andrew and Anna, get entitlement to their assets after they die.
Therefore, they should set up mirrored wills, whereby Mrs. A gives Mr. A life interests in their family home, then they name Andrew and Anna as beneficiaries and vice versa for Mr. A.
They appoint other family members to be their trustees, so they have a duty to look after the property for the surviving spouse and Andrew and Anna.
In the scenario where Mrs. A dies first, Mr. A gets continued enjoyment of the house for the rest of his life.
However, as per the trust regime, in the situation where he marries Bonnie and has a son called Ben, when he dies, Andrew and Anna are still fully entitled to Mrs. A’s share of the property.
If there had not been a trust, then Mr. A would have gotten all of the property when Mrs. A died.
Then when he died, all his property would have gone to his new wife Bonnie, and then on her death, all the capital and the property would have gone to Ben.
Therefore, Andrew and Anna would have not gotten anything.
What is a ‘flexible life interest trust’?
This is a form of life interest trust where you write in more conditions on what is done with your assets.
You can make sure that the life tenant gets capital from the estate, which then is recalled from their share of the property to be repaid to the trust fund after their death.
This form of trust is especially useful for families where the husband or wife has children from a previous marriage.
When you set up this type of trust, you should write an expression of wishes letter, so the trustees know what you want to happen.
What duties do trustees have?
Trustees hold the legal interest of the trust. This means they are responsible for the administration of the estate both for the life tenant and then for the beneficiaries once the trust comes to an end.
How much power the trustees have will be written into the will.
The trust can be discretionary, so the trustee will have discretion over how the trust funds are distributed.
Are life interest trusts a good idea?
Trust wills are useful to give you the independence to ensure your property is distributed amount your family members as you want.
If you do nothing, your partner may inherit your entire estate as per intestacy rules on your death. There are risks to passing your money directly to your children as a gift, and this may not provide for your spouse’s housing needs.
Therefore, putting your property in trust in your will is a good idea if you know how you want your assets to be distributed on your death.
You should get legal advice from a solicitor or expert if you are considering this option, as to whether it is right for you depends on the nature of your estate.
What are the advantages of a life interest trust?
There are pros and cons to life interest trusts that are worth considering. The advantages can include:
- You can do what you want with your property during your lifetime, and change your will whenever you want.
- There is the flexibility to set up the right type of trust will. You will have the peace of mind in the knowledge of what will happen to your trust property. Individuals will have more control than if they give an asset as a gift to others.
- A flexible life interest trust can ensure the surviving spouse can access the money and assets too.
- Unlike a lifetime trust or interest in possession trust, you have the flexibility to move property around while you are alive without a conveyancing fee.
- You ensure that your wife, husband or civil partner have a life interest in the property after your death, so can continue to live in your house, while preserving the capital value for the beneficiaries, normally the children.
- Putting your assets in trust will protect your property and assets against a financial assessment by the local authority. This is only true if the council does not deem there to be deprivation of assets.
- The trustees cannot remove your spouse from the property after your death.
- You may avoid probate fees.
- Possible tax advantages.
What are the disadvantages of life interest trusts?
However, there are life interest trust disadvantages. These can include:
- A life interest trust will cost to set up. In the event that the local authority thinks there has been deprivation in assets, then the possession trust will still be assessed for care fees.
- There can be unintended income tax, capital gains tax and inheritance tax consequences.
- The trust owner needs to be careful in who they choose as a trustee, as according to the arrangement, they will own all the money and property in the trust.
- If you remarry, there can be issues.
- Probate may still be necessary.
What are the tax consequences of a life interest trust?
Some people set up life interest trust wills for tax reasons, especially inheritance tax purposes. However, whether this is effective depends on the drafting of the trust.
Normally, on the death of a beneficiary, IHT is not payable on the assets in the life interest trusts.
Generally, transferring an asset into a trust on death will attract IHT.
If the total of the assets passing to beneficiaries, alongside any gifts made by the settlor in the seven years before their death is less than £325,000, inheritance tax will not be due.
Where the life tenant is a surviving spouse then IHT is not payable on assets in the property trust.
During the trust lifetime, the life tenant is viewed as entitled to the capital, so when they due it is treated as though they are transferring the funds to the beneficiaries.
Capital Gains Tax
Trustees will have to pay capital gains tax at 20% if it is over the trustee’s annual exemption.
Trustees generally have to pay income tax at the basic rate of 20%, but 7.5% on dividends received.
The life tenant can reclaim tax if they are not liable to pay it. The tax treatment depends on their nil rate band.
Can I use a life interest trust to avoid care fees?
In England and Wales, if your assets are worth over £23,250, you will be liable to pay for your individual care fees.
While the assets being in a trust will mean that they do not come within the surviving spouse’s estate, avoiding care home fees cannot be the main reason for setting up the trust. This is called deprivation of assets.
In fact, if the person’s health was already deteriorating when the trust was set up, it is likely the council will think there was a deprivation of assets, and assess the trust fund as though it was part of their estate.
Hence the trust property may still be used to pay care fees.
Of course, as the trust does not exist in your own lifetime, it cannot be used to avoid your individual care fees.
What do I need to do before setting up a life interest trust?
One important consideration is whether the ownership of your house between you and your spouse is as joint tenants or tenants in common.
If you and your spouse or civil partner hold the house as joint owners, on one’s death, the other’s share will be passed on to the surviving spouse.
If you want to leave your share in the house to the trust, you will need to change the title deeds with the land registry so that you and your partner have ownership of the property as tenants in common.
You also should appoint a wills service to help you draft documents to avoid unintentional tax consequences.
A solicitor’s firm or experts will charge a price, however, this is necessary to avoid costs later. You can contact solicitors to ask a question or if you want to explore your options.
You should choose a firm that is authorised and regulated by the SRA.
What happens if the life tenant wants to move house?
This is common where the widower wants to downsize. In these circumstances, any surplus money from the sale of the family home that does not go to purchasing the new property will be distributed between the life interest beneficiary and the trust account for the remaindermen.
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