The advantages of life interest will trusts

The inclusion of a life interest trust in your will can have its advantages.

A life interest trust is often used in a will to provide flexibility with capital protection. It can be a popular choice for couples concerned with their estate being depleted after one of them has died. It is also a popular structure for couples with children from more than one relationship or couples who have been married more than once, as it can help to balance the competing needs of beneficiaries.

What is a life interest will trust?

A life interest trust provides the ‘life tenant,’ who is defined within the will, with the right to income generated from the assets placed into the trust as well as the right to occupy any property placed within the trust. The life tenant is often a surviving spouse or civil partner, but not always. There are usually various administrative provisions to guide the trust administration. A flexible power to appoint capital to the life tenant can be included. The will goes on to provide for what will happen to the capital held in the trust on the death of the life tenant, or if the trust comes to an end at an earlier date. This may be an absolute distribution of funds to children for instance who would be called the ‘remaindermen’ or ‘remainder beneficiaries.’ Alternatively, the trust provisions may provide to settle the capital onto the terms of another trust, such as a discretionary trust for children and grandchildren.

Why might a life interest will trust be used?

The main reason this structure is popular is the ability to preserve capital for the next generation in the life interest trust structure. A complexity, however, of this structure is the trustees need to balance the interests of both the life tenant and the remainder beneficiaries.

A life tenant who has vulnerabilities, such as a concern they may spend or be influenced to spend their inheritance unwisely, may benefit from the protection of a life interest trust structure. Under the current rules, although these may be subject to change, the structure can assist a life tenant who is entitled to receive means tested benefits to continue to be eligible for these.     

The life interest trust structure can also provide flexible support to the surviving life tenant to ensure they are comfortable, but limiting the access to capital unless the trustees determine otherwise. A detailed letter of wishes can be prepared with the will to provide guidance to your trustees on how to support the life tenant for the duration of the trust.

What assets can pass into a life interest will trust?

The life interest trust structure can be utilised with large capital assets, such as the family home, or with cash and investments. Couples wishing to utilise this structure must ensure their property is held as “tenants in common” to ensure their share of the family home passes into the life interest trust structure in their will rather than to the surviving joint holder by survivorship.

A mortgage on the family home does not prevent the use of a life interest trust structure. However, care must be taken to provide for the mortgage responsibility or discharge within the will.

What about tax considerations?

On the death of the life tenant, the trust fund is added to their estate for inheritance tax purposes. As such, a benefit to this structure is the eligibility to qualify for the transferable allowances from the death of a former spouse or civil partner, and to qualify for the residence nil rate band even if the only qualifying residential interest is a property within the trust.

The life interest trust structure has another tax benefit, (based on current rules), of allowing the trustees to claim principle private residence relief for capital gains through the life tenant on the sale of a property occupied by the life tenant.

The trustees can also simplify the tax reporting for the trust by remitting the gross income directly to the life tenant to personally report to HMRC.

What are the disadvantages?

There are, therefore, a range of advantages to the life interest trust structure for a will. However, it is worth bearing in mind the potential negative aspects to this structure which include:

• that a trust will need to be administered for the lifetime of the life tenant, which could be decades
• it does not necessarily mitigate inheritance tax as the value of the trust fund will form part of the life tenant’s estate on death
• a long-running trust will often require input from professional advisers which will come with ongoing professional costs
• the life tenant can begrudge having to ask the trustees for additional support
• the choice of trustees is important. Family members with competing interests could have difficulty reaching unanimous decisions on the administration of the trust
• property maintenance can become difficult for an elderly life tenant to maintain and the trustees need to ensure they have cash funds to support and maintain what is often the main asset of the trust, and
• this option does not work in all scenarios, for instance for a single person.

These potentially negative aspects to a life interest trust can be mitigated by taking professional advice on your choice of will structure.