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Flexible Life Interest Trust and how it applies to you

There are circumstances in which you wish an occupant of your home to stay until they die after you have gone, but you wish the asset of the home to be passed onto someone else so that it is protected from anyone accessing the asset of the home until after the occupants death (and even then there are numerous reasons why you would wish the property and income remain in a trust).  This may apply to a spouse where the type of ownership of the property can be converted if needed and they can be given a life interest in the house whilst the house is put into a trust for the benefit of others, for example children.  (There are pros and cons to this for the surviving spouse).  You may own the house and have started a new relationship but have family from your former spouse you wish to leave the house to, but wish to allow the new partner a period of time to occupy the house which does not rely upon their death so another kind of trust/arrangement can be made.  As you can see below, there are further pros and cons.  Tipi Wills & Mediation can talk with you and guide you, weight up the pros and cons with you to help you make the best decisions for your needs and take you through how to do what is needed.  You will find some organisations simply sell you a trust and do not take you through the pros and cons, telling you any property or life interest trust is a good thing, but we believe it is important you understand it before purchasing this service particularly as there are some powers to have trusts overturned.

Reasons to Use a FLIT but what is a FLIT?

A Flexible Life Interest Trust (FLIT) is essentially a mixture between a life interest trust and a discretionary trust that can also be changed into different type of trust at any point. The trust will name a life tenant and other discretionary beneficiaries. Whilst the life tenant, who is usually the testator’s surviving spouse or civil partner, is alive they are entitled to all income generated by the trust. The trust also includes a discretionary power that allows the trustees to advance capital to the life tenant.

When the life interest ends the trust will then continue as a discretionary trust for the discretionary beneficiaries. The life interest will normally end on the life tenant’s death, but this may be earlier as the life tenant may relinquish part or all of their life interest or alternatively a FLIT may include a power for the trustees to revoke part or all of the life interest.

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Asset Protection

Asset protection is likely the main reason to place assets into a FLIT. Normally a FLIT would be used by a parent wishing to continue to benefit their spouse or civil partner but wish the assets continue to be protected for their children.

Whilst the life tenant of the trust is alive the trustees can benefit the life tenant, through the entitlement to income and the discretionary power to advance capital, but the assets held by the trust will be protected from third party claims such as bankruptcy or remarriage.  This mechanism can help the growing problem of accidental sideways inheritance.

The other discretionary beneficiaries are also protected through the discretionary trust when the life interest ends. They are not entitled to the trust fund outright, and instead inherit at the discretion of the trustees and therefore will be protected from third parties. The trustees could then give that beneficiary occasional benefits until such time that the Trustees consider it safe for the beneficiary to inherit outright.

It is advisable for the testator to have a letter of wishes to guide the trustees on how they should distribute to the discretionary beneficiaries.

 

Flexibility

A FLIT offers flexibility as to how the trustees will benefit the beneficiaries of the trust. It may not always be sensible for each beneficiary to inherit capital outright.

The testator may for example wish for the trustees to make small gifts of capital to the life tenant outright or loan them large amounts of capital that would be repayable to the trust on death.

It may be the case that some of the discretionary beneficiaries already have assets exceeding the NRB themselves and do not wish to give themselves further tax liability. For them it may be more appropriate to only receive occasional benefits or loans of capital from the trust rather than receiving their ‘share’ outright.

A FLIT allows for the Trustees to convert some or all of the trust fund into another type of trust, so if IHT laws change in the future and make it more tax efficient for the fund to be in a different trust, the Trustees will be able to make that change.

IHT Planning

On the testator’s death, the trust assets will be seen as passing to the life tenant of the FLIT for IHT purposes. Assuming that the life tenant of the FLIT is a surviving spouse or civil partner, there will not be any IHT due from assets passing into a FLIT on the testator’s death as the spousal exemption will apply. The NRB will therefore not be used and available to transfer. The trust assets will form part of the life tenant’s taxable estate and both NRBs can be used on second death.

Between the testator’s death and the life tenant’s death, the trustees and life tenant could attempt to make gifts from the trust to the other beneficiaries as a form of IHT planning. Any gifts made to the other beneficiaries would be seen as a potentially exempt transfer from the life tenant’s taxable estate and the usual 7 year rule will apply.

Whilst the life tenant is alive, there are no anniversary or exit charges to pay. These charges will apply for assets over the NRB after the trust becomes a discretionary trust.

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Disadvantages

Unmarried couples may consider using a FLIT, but they will be disadvantaged as they do not benefit from the spousal exemption or transferable NRB and other options may need to be considered.

A FLIT may not allow for full RNRB to be claimed.

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Note from Tipi Wills & Mediation :  These kind of trusts are not suitable for everyone and should be considered in the whole context of  your future plans to ensure the availability of funds and assets if required before and after death.

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Article courtesy of Willpack.co.uk who work in association with the Society of Will Writers.  If you require any advice they recommend contacting the Society of Will Writers to put you in contact with a will writer local to you such as Tipi Wills & Planning

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Tax Treatment 

(Financial advice must be sought from a separate and independent registered financial advisor)

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Capital Gains Tax

The trustees are a separate entity for Capital Gains Tax purposes and are liable to pay tax on any gains they make over and above their annual allowance. The annual allowance for trustees is half of that of an individual – currently (2020-2021) £12,300 (£6,150 for trusts).

If a Life Tenant of the trust is occupying a property owned by the trustees then the trust can mitigate Capital Gains Tax by using the main residence relief provisions.

Any investments owned by the trustees should be carefully managed to reduce this tax burden. Any transfer of an asset out of the trust may give rise to a liability if there has been a substantial gain prior to distribution.

In an IPDI trust or a life interest trust created before March 2006, on the Life Tenant’s death any assets owned by the trust at that point are revalued for Capital Gains Tax so that there is no gain or loss to the trustees.

Capital Gains Tax is payable at a flat rate of 28% but this is subject to change by the Government.

Income Tax

The Life Tenants will have a right to income as it arises and this will usually mean that income is mandated to them (paid direct automatically). Such income would be declared on a Life Tenant’s own tax return and taxed accordingly.

Some income may still have to be declared by the trustees, for example non-mandated foreign income, accrued income on gilts and deeply discounted securities. The trustees may have to declare this income and pay tax on it at the rate applicable to trusts (currently 37.5% for dividend income and 45% on other income).

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Inheritance Tax

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Assets held within the trust are treated for Inheritance Tax purposes as if they belong to the Life Tenant.  If the trust is brought to an end during the Life Tenant’s lifetime, the Life Tenant is treated as having made a Potentially Exempt Transfer (PET) for Inheritance Tax, equivalent to the capital value of the trust.  If the Life Tenant dies within 7 years of the termination of the trust, the PET will be aggregated with their own estate for calculation of Inheritance Tax.

If the trust comes to an end on the death of the Life Tenant, again the capital value of the trust will be aggregated with the Life Tenant’s estate to calculate Inheritance Tax due.  If the value of the trust and the estate together exceed the Nil Rate Band (currently £325,000) tax will be due at 40% on any excess and this will be apportioned between the trust and the estate.

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The trustees and executors can make use of the usual exemptions (eg, where trust or estate assets pass to a surviving spouse or to charity), and the transferrable nil rate band rules (where the Life Tenant is a widow or widower), to reduce the tax payable.

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The Trust is not subject to 10 yearly charges or charges when an asset leaves the trust, unlike the tax treatment of Discretionary Trusts.

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Be in control.  Be Certain

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