Life Interest Trust Guide

There are many types of trusts, and a life interest trust is one of them. You may include it in your will, in which you name the person or persons who will have rights your property. This way, you can protect your loved ones in the future when such rights are threatened.

Generally, a life interest trust can help you preserve your assets and avoid paying inheritance tax, but it is also popular for so many other reasons, wuch as flexibility. If you’re married, other parallel trusts automatically pass all your assets to your spouse or partner. With a life interest trust, you can leave some of them to other members of your family and even to other beneficiaries.

While it is instantly created by the first death in your marriage or civil union, you can set up a life interest trust in advance. Through this trust, your surviving spouse or partner will receive an income for life. When they die, the trust will be be transferred to your next-in-line beneficiaries, who would most probably your children. If your surviving spouse or partner ever needs care in the future, the trust will often be excluded in the financial assessment. 

Why Create a Life Interest Trust?

You can have many specific reasons for setting up a life interest trust, but the overall idea is to protect your beneficiaries for life, as well as your assets or properties across generations. When you pass on, the person who survives you will leave the trust in the care of another person, called a trustee, who is tasked to pass the trust to your surviving children once your surviving spouse or partner dies.

While this sounds perfectly innocent in theory, many things can happen in real life and cause issues that ultimately lead to the improper or unintended distribution of the estate.

For example, if one spouse or partner dies and the other enters care, their combined estate could be easily depleted by care fees. Or if the surviving party remarries and doesn’t make a will, or makes a will that leaves everything to the new better half, the children of the first marriage or civil union may receive little or nothing at all. This is known as the sideways disinheritance trap.

Additional Marriages

Of course, you don’t want any of that for your family, and avoiding it can start from knowing the different scenarios that can make a life interest trust worth setting up. For example, when you die and the party who survives you remarries, you want to be sure that your children inherit what is theirs. Or if you have remarried, a life interest trust will make sure your children from a past marriage or civil union inherit what is due to them upon the death of your spouse or partner. Another scenario is when you want a loved one to inherit their but you’re afraid they would squander your assets away. You can set the terms for the life interest trust in a way that prevents this from happening (you can seek a lawyer’s advice on this).

A particularly complicated scenario that makes life interest trust necessary involves one example we mentioned earlier – care fees and your home. If you and your spouse or partner co-own a house and one of you has to enter residential care, the local authority will not be interested in the property as long as one of you is still living in it.

Financially Supported Care

However, if you pass on and your spouse or partner, now the sole owner of the house, requires care, the property will be considered by the local authority when deciding whether or not your surivor can financially support their own care. In many cases, people simply dispose of their assets to be able to pay for their care – unless they have a trust.

Aside from protecting your assets against home care costs and the assurance that your beneficiaries will inherit their part regardless of the circumstances, a life interest trust can also be converted into different types of trusts when necessary. That means you can have more peace of mind, knowing you won’t be stuck with something that no longer works when your situation changes.

Life Interest Trust Parties

As the person creating the trust, you are referred to as the settlor (or a donor, or trust-maker, trustor or grantor). You will pick a third party, or trustee, to take care of your assets for your beneficiary, or the person you want the trust to benefit. The law allows you to have more than one trustee or more than one beneficiary for this trust.  

Settlor

As a settlor, you will be making the decisions that affect how the trust’s assets must be used. Such terms will be formally stated in a legal document known as a trust deed. As soon as the assets have been placed in trust, you cease to own them as they will now the legal property of the trustee, although the trustee is still required to ensure that the beneficiaries receive what is due them.

Trustee

A trustee is the person or company handling the assets in the trust as they are intended for the beneficiaries. Trustees should not personally benefit from their role unless they are working in a professional capacity and thus entitled to a fee. Another job of the trustee is to ensure that assets are invested wisely, if applicable, and that all taxes are paid on time. They must also keep accurate accounts and records, kept totally separate from their own personal finances. In the case of breaches, trustees can be held liable, so it’s crucial for them to seek and follow advice from a lawyer who can help them get a full grasp of their responsibilities. A trustee may be removed or replaced, depending on the terms of the trust.

Beneficiary

The party that benefits from the assets held in trust is called the beneficiary. With a revocable trust, or one that the settlor is allowed to change or take back anytime, the beneficiary has no rights until they start benefiting from the trust’s assets, except when the beneficial is the settlor as well. In any case, revocable trusts are lifetime trusts by nature.

On the other hand, an irrevocable trust is one that is no longer subject to change, even by the settlor, unless there is a court order that supports the planned modification. In this case, the beneficiaries will have specific rights, depending on the terms of the trust before it is redeemed. They can be confident that the trustee is protecting their interests by asking to look into the accounts and records.

Disadvantages of a Life Interest Trust

Then again, just like any other financial product, a life interest trust is not perfect. You can’t just pick any trustee, for one, and for quite obvious reasons. It must only be a person you can trust with all of your heart and mind. Some trusts will also not come with substantial tax relief until the trustees pass on. And should your circumstances change significantly, such as when you remarry, the trust’s terms can be affected.

In other words, a life interest trust is not a perfect financial product just like all the rest. All your survivors have is access to the fund’s income or the right to continue staying in your property. This can seem very restrictive, and in some cases, a spouse or partner may not enjoy having to work with or be answerable to trustees.

Should the beneficiaries be younger than 18, the trusts can be almost impossible to dissolve. Such trusts may be extended to let the trustees pay money to your spouse or partner if needed, but this is not something they can legally demand. Also, a life interest trust may not be as free-flowing  as full discretionary trusts, and extra procedures may be necessary to set up investments or make any changes to the property.

The good news is, compared to the above cons, the advantages of a life interest trust are still overwhelmingly greater. 

Life Interest Trust Taxation

Tax perks are another factor behind the popularity of life interest trusts. Generally speaking, when a beneficiary passes on, there is no inheritance tax to be paid on the trust’s covered assets since they are not essentially part of the deceased beneficiary’s estate.

How a life interest trust is treated tax-wise has something to do with whether or not it is classified as “relevant property.” This is determined at the time the trust is being set up. Life interest trusts set up while the settlor is alive after March 22 , 2006 are considered relevant property, along with those created before this date where there are changes in the list of beneficiaries beyond October 6, 2008.

If a trust qualifies as relevant property, an inheritance tax of 20% must be paid, as long as the gift is worth a certain amount set by authoriies. This relevant property will then be taxed every ten years at up to 6% of the asset’s value. For any asset removed from the relevant property trust, there will also be a charge.

On the other hand, a trust whose assets aren’t considered relevant property will be considered a Potentially Exempt Transfer (PET). That means no inheritance tax will be paid so long as the settlor is alive beyond seven years from the time the assets were added into the trust. And unlike relevant property, a PET doesn’t come with regular tax liability.

However, since a trust’s beneficiaries are deemed the owners of the assets, they will be taxed at a rate based on their income. If they are earning from dividends, the rate will be 10%; for other forms of income, this can go as high as 20%.

Joint Ownership

In case you co-own your house with another person, how much is actually yours of the property will instantly go to the surviving co-owner, regardless of your will’s terms. Hence, before setting up a life interest trust, you should make sure that you own your property as tenants in common. If the property is registered, check with the Land Registry; if it’s unregistered, look into your title deeds. But remember that if you own a property with another person, you have to cut that joint tenancy before you can properly create a life interest trust.

Alternative Properties

During the trust period, the life tenant may be able to ask to purchase an alternative property if they want to, and any extra proceeds from this would be held by your trustees and managed for your beneficiaries. But if you also want to give the life tenant a right to income and stay in your property, they will be entitled to receive any earnings from the capital.

Life Interest Trust Coverage

The period covered by a life interest trust depends on the will. For example, it may provide that the trust continue until the beneficiaries are of a certain age. When such a time is reached, the assets will be distributed according to the terms indicated in the will. In other cases, a will may provide that the trust apply for the entire lifetime of the beneficiary. That means the beneficiary will receive income from the assets placed under the trust for as long as they’re alive. When they die, the capital will be treated according to the dictates of the will.

Setting Up a Life Interest Trust 

Creating a life interest trust can be a complex process, depending on your particular circumstances and desires. Hence, you should seek professional advice from a trusted lawyer or from a financial advisor specializing in trusts. Family members may also offer some insights that can help you make decisions.

And, of course, you need to appoint trustees to manage the trust on your behalf. Remember, your trustees will be able to act by themselves, having full control over your assets until these are transferred to your beneficiaries. Needless to say, you must be extremely cautious when choosing who your trustees should be. Make sure they will fulfill their duty of preserving the life tenant’s best interest.

Of course, a life interest trust is something you’ll want to set-up expertly, fulfilling all legal requirements and maximizing the benefits for your nominated beneficiaries. Hiring a lawyer therefore makes perfect sense, but as you might expect, this will increase your costs as well.

Life Interest Trust Will Cost

Solicitor fees for creating a trust can go anywhere from £800 – £1500 for individuals and between £1200 and £1700 for couples. Location plays a part in all of this, where a trust set up in a major city would naturally cost more than one that is created in a small town. Will drafting fees, on the other hand, cost around £200 to £400 for individuals and £300 to £500 for couples.

Conclusion

A life interest trust can be drafted into your will or set up upon your demise. Either way, it is crucial to define your goals before taking action. And whatever they are, you can be sure of one thing: a will lets you control where your assets go when you die and ensures that your beneficiaries receive their share when it’s time. In other words, you can have peace of mind knowing that their future is secured and your assets are safe against bankruptcy, divorce and every other potential threat. 

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