What is a life interest trust?
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. It can also cover other potential 'trigger factors' i.e. circumstances where the trust would come to an automatic end, for instance if the life tenant started a cohabiting relationship which exceeded a fixed period of time (six/ twelve months typically) or if they were to move into permanent care or voluntarily vacate the property.
A life interest trust can 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 or you wish to ensure the whole of your estate does not pass to the survivor on the first death, thereby potentially being fully utilised towards the payment of care home fees.
Taxation of life interest trusts
A life interest Will trust is taxed as though the assets within the trust are part of the life tenant’s own estate which means that while the trust continues, there is no inheritance tax to pay.
When the life interest comes to an end, there may be an inheritance charge:
IHT of 40% is payable if the life interest ends on the life tenant’s death.
IHT of 20% is payable if the life interest is terminated during the life tenant’s lifetime and passed to a relevant property trust (e.g. a discretionary trust).
There is no inheritance tax to pay if the life interest is terminated during the life tenant’s lifetime, the life tenant survives seven years from the date of the termination and the assets are passed outright to an individual or to a trust which benefits from favourable tax treatment (e.g. a disabled person’s trust or a bereaved minor’s trust).
(A relevant property trust is any trust that is subject to the ‘relevant property charging regime’ for inheritance tax; and it includes discretionary trusts).