If a life interest trust is created by a will, the beneficiary entitled to the life interest is called the life tenant and has what is known as an ‘immediate post-death interest’.
The life tenant is entitled to receive the income from the trust during their lifetime, and on their death the assets pass to other beneficiaries named in your will.
If there is a property in a life interest will trust, the life tenant may be entitled to live in the property or to receive the rental income from it for the rest of their lives. In some instances the trust may allow the property to be sold and a new one bought for the life tenant to live in during their lifetime. This would allow them to downsize or relocate following the death of the testator. The will can state that the life interest should come to an end if the life tenant should marry or enter into a civil partnership.
A life interest trust can also be an effective way of ensuring that your spouse or civil partner is able to carry on living in the family home whilst passing the value of the property onto other beneficiaries when your spouse or civil partner dies. This sort of estate planning can be particularly useful if you have children from a previous relationship who you would like to benefit after your current partner’s death.
How are Life Interest Trusts Taxed?
The tax treatment of lifetime trusts is worth considering carefully. Because you gift the house to the trust, it can attract inheritance tax if it's worth more than the nil-rate band (currently £325,000).
Those who transfer their property to a lifetime trust may face an immediate 20% charge on any balance over £325,000 (including gifts made in the previous seven years), while the trustees must submit tax accounts to HMRC. They may have a further tax bill every 10 years, worth 6% of the value over £325,000, plus income tax on any payments from the trust, plus exist charges on assets.
If the trustees sell assets within a trust, these may also be subject to capital gains tax. These may also apply if a trust is liquidated and everything is passed to the trustee.
Capital gains tax will be calculated the same way as it is for individuals, though the annual allowance is smaller - £3,000 in 2023-24 and £1,500 in 2024-25. The exception is if the trust has been set up for a someone disabled - in which case the annual allowance is £6,000 in 2023-24 and £3,000 in 2024-25.
It's always important to seek advice before setting up a lifetime trust, as the tax implications can be significant. This is especially true if the beneficiaries of the trust aren't UK residents, as the rules can quickly become even more complicated.
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