When it comes to estate planning and ensuring the financial security of your loved ones, life interest trusts can be a powerful and versatile tool. In this guide, our expert Wills, Trusts and Probate solicitors explain what a life interest trust is, when it might apply and when it is beneficial to take advantage of this option.

When incorporated into a will, a life interest trust can offer a solution that balances the interests of your loved ones. It ensures the financial well-being of your spouse during their lifetime while protecting your children's inheritance for the future.

Protecting assets for your children while still allowing a surviving spouse to benefit from them is becoming an increasingly common issue for modern families, particularly in cases where there are second marriages and stepchildren.

In this comprehensive guide, we will explore the role of the life interest trust, how it works, and the advantages it can offer. We hope this information will enable you to make more informed decisions in relation to your estate, and protect the interests of your family when planning for the future.

If you have any questions we have not answered, our expert Wills, Trusts & Probate solicitors are happy to speak to you regarding your query and provide the legal services you need. You can contact us by completing the enquiry form below or by calling 0151 666 9090.

What Are Life Interest Trusts?

Life interest trusts, also known as interest in possession trusts, are a type of trust written into your will. They are commonly used in estate planning to safeguard assets and ensure financial security for loved ones.

In a life interest trust, a particular beneficiary, known as the “life tenant”, is granted the legal right to receive any income generated by the trust's assets or to use property held within the trust during their lifetime. The life tenant is usually a surviving spouse.

This unique arrangement allows the settlor (the person establishing the trust) to ensure that their chosen life tenant enjoys the benefits of the trust assets without granting outright ownership. Once the life tenant passes away, the assets (the “life interest”) are then transferred to the named beneficiaries, usually the children of the settlor.

A life interest trust can be created in respect of your entire estate, or in relation to one or more specific assets.

What Is a Life Interest Trust of Property?

One of the most common scenarios in which you might use a life interest trust, and the easiest to understand, is in relation to property. A life interest trust of property occurs where a house is left to a surviving spouse to live in during their lifetime, but when they die, the property passes to the original settlor’s beneficiaries.

In this scenario, the surviving spouse cannot leave the trust property in their will because they do not own the property, and their interest ends on their death.

In order for this to work, the property must be held as tenants in common, where each party owns a share of the property. A sole owner can also create a trust so that the beneficiary can benefit from the asset during the rest of their life, but the asset will pass to the settlor’s chosen beneficiaries.

This type of trust is commonly used in estate planning to balance the needs of the surviving spouse and the desire to pass on assets to future generations while protecting against potential issues such as care home fees or remarriage.

What Are the Advantages of a Life Interest Trust?

A life interest trust offers several advantages, making it a valuable estate planning tool for many individuals. Here are some of the key advantages:

Financial Security for the Surviving Spouse

One of the primary benefits of a Life Interest Trust is that it ensures your surviving spouse or partner can continue to reside in the family home or benefit from the trust's assets during their lifetime. This provides them with much-needed financial security and stability.

Control Over Asset Distribution

With a life interest trust, the settlor can control how their assets are distributed after the life tenant's death. This is especially valuable in blended families or situations where there are specific beneficiaries the settlor wishes to provide for.

Asset Protection

By placing assets in a life interest trust, they are protected from being taken into account when means testing for care home fees or other potential financial liabilities. This safeguard ensures that the assets remain intact for the beneficiaries' inheritance after the life tenant dies.

Mitigation of Inheritance Tax (IHT)

Life interest trusts can be used as part of inheritance tax planning strategies. You may be able to use a life interest trust for inheritance tax purposes and take advantage of allowances and exemptions available within the trust structure to mitigate your IHT liability.

Protection Against Remarriage

In cases where a surviving spouse remarries, a life interest trust can prevent the new spouse from inheriting the assets, as they are ultimately reserved for the chosen beneficiaries named in the trust. This means that when the surviving spouse dies, the assets will be distributed according to your original instructions.

Flexibility in Trust Provisions

Life interest trusts can be tailored to suit the specific needs and circumstances of the settlor and their beneficiaries. This flexibility allows for a wide range of provisions and can accommodate changing family dynamics over time.

Are There Any Disadvantages to Life Interest Trusts?

While life interest trusts offer valuable advantages, they also come with certain disadvantages that individuals should consider before incorporating them into their estate planning. Here are some of the potential drawbacks:

Complexity

Setting up and administering a life interest trust can be complex and often requires legal assistance. The process involves registering the trust with the Trust Registration Service, drafting trust documents, changing property titles, and ensuring legal compliance. Percy Hughes & Roberts can walk you through the setup of a life interest trust.

Limited Access to Capital

The life tenant may only have access to the income generated by the trust assets, not the capital itself. This limitation can be restrictive, especially in cases where the life tenant requires access to a significant sum of money.

Potential Family Disputes

Life interest trusts can sometimes lead to family disputes, particularly if beneficiaries feel they are not receiving their fair share or believe the life tenant is misusing the trust assets.

Duration of Trust

Life interest trusts can last for a considerable period, which may extend for several decades, especially if the life tenant lives for a long time. This long duration can create uncertainties and delays in distributing assets to the final beneficiaries.

Tax Implications

Life interest trusts can have tax implications. Understanding and managing these tax implications can be complex and you may require professional advice - in some cases, you can make significant tax savings, but in others you may end up paying more unless you manage your trust effectively.

For some individuals, especially those who own property and other assets that are very high-value, a life interest trust might not be the most tax-efficient option compared to other estate planning strategies.

How Can I Set up a Life Interest Trust?

Setting up a life interest trust can be a complex legal process, and it is crucial to seek professional advice to ensure it is done correctly. Here are the general steps to set up a life interest trust:

Seek Professional Advice

Consult with a qualified solicitor or estate planning expert who specialises in setting up trusts. They will assess your specific situation, understand your objectives, and recommend whether a life interest trust is the appropriate option for your estate planning needs. Our expert Trustee Solicitors at Percy Hughes & Roberts are able to assist you with this.

Identify Beneficiaries

Determine who the life tenant (usually the surviving spouse) will be and who the ultimate beneficiaries (remaindermen) will be after the life tenant's death. You must include their names and any specific conditions or limitations.

Choose Trustees

Select trustees to administer the trust and manage its assets according to your wishes. Trustees can be family members, friends, or professional trustees. You should appoint at least two trustees, and ensure they are individuals you trust and who have the ability to fulfil their fiduciary duties. You can learn more in our guide on What is a Will Trustee? It may be best to appoint a professional to fulfil this role, to avoid any family conflict.

Draft the Trust Deed

Work with your solicitor to draft the trust deed, which is a legally binding document outlining the terms and conditions of the trust. The trust deed should include details of the assets to be placed in the trust, the rights of the life tenant, and the distribution of assets upon the life tenant's death.

Register the Trust

If applicable, you will need to register the life interest trust with HMRC's online Trust Registration Service. This is mandatory for trusts with tax implications, and your solicitor can advise you on whether or not this will be necessary.

Transfer Assets to the Trust

To establish the trust, you need to transfer the assets intended for the trust (e.g., property, investments) into the trust's ownership. This may require changing property titles and other legal processes.

Regular Review

Keep the trust deed under regular review and update it if there are any significant changes in your circumstances or preferences.

When Do Life Interest Trusts End?

Life interest trusts can end under various circumstances, depending on the terms specified in the trust deed. The most common scenario, however, is upon the death of the life tenant.

Some life interest trusts may also terminate if the life tenant remarries or starts cohabitating with another person. This condition is often included to protect the interests of the ultimate beneficiaries (remaindermen) and ensure that the assets are not diverted to a new spouse or partner.

In addition to this, the trust deed may set a specific time period for the life interest trust to end, regardless of the life tenant's status. For example, the trust may state that the life interest will last for a certain number of years or until a specified date.