19th November 2024

Will Trusts – a brief guide

One thing we are asked about frequently, and one of the most complicated aspects of Wills, is trusts and how they work, how they can be utilised in your Will, and the relevant tax consequences. Trusts are frequently misunderstood by clients as they can be difficult to explain without over complicating matters causing clients to shy away from including them in their Wills. However, they are an extremely effective tool for structuring your assets, and once understood correctly, can be incorporated into your Will in different ways according to your individual circumstances to ensure your assets are protected effectively.

Below is a summary of the main types of will trusts:

 

Interest in possession trust (IIP) – commonly known as a Life Interest Trust

  1. Assets are gifted to a named beneficiary for the duration of their life (the “Life Tenant”) which means the Life Tenant is entitled to the benefit of the capital assets for the duration of their life. This can be the right to live in a property. They are not entitled however to spend the capital assets.
  2. The Trustees must pay the income to the Life Tenant, and they have no discretion as to whom may benefit from the Trust assets.
  3. Retains the spouse exemption (assuming life tenant is the spouse) so that there will be no Inheritance Tax to pay on the first death if everything is left to a surviving spouse whether absolutely or by way of a Life Interest Trust.
  4. Ensures security of tenure for a surviving spouse particularly if there is a property in the estate in which they are living.
  5. Preserves the capital assets for the ultimate named beneficiaries who have a vested interest on testator’s death albeit they are not entitled to the capital assets until the Life Tenant dies.
  6. Trust automatically comes to an end on Life Tenant’s death.
  7. No exit charges or 10 yearly anniversary charge.
  8. Transferable Nil Rate Band (NRB) and Transferable Residence Nil Rate Band (RNRB) is preserved, assuming no assets above the available NRB and RNRB have been disposed of by the Will or during the testator’s lifetime to anyone other than their spouse.
  9. Trustees can be given overriding power of appointment to distribute capital to Life Tenant either as a payment out or a loan. Any outright gift of capital will be considered a gift from the Life Tenant’s estate.
  10. Property in the estate can be sold and the equity used to purchase another property on the same terms which can free up the Life Tenant’s own cash assets. Or the equity can be invested and the Life Tenant can receive the income.
  11. Capital assets are considered part of the Life Tenant’s estate for Inheritance Tax (IHT) purposes.
  12. Income tax is paid at the Life Tenant’s rate.
  13. On Life Tenant’s death, beneficiaries are immediately absolutely entitled in shares as defined in the testator’s Will.
  14. If the Life Tenant gives up their interest, then it will be considered a Potentially Exempt Transfer (PET) against their estate, and they must survive 7 years for it to fall out of their estate for IHT purposes.

 

Relevant Property Trust (RPT) – commonly known as a Discretionary Trust

  1. Assets are placed into a trust, the income and capital of which are completely controlled by the Trustees.
  2. Creates a pool of beneficiaries who can be named or unnamed.
  3. Beneficiaries do not have a vested interest in assets and are not entitled to any of the capital or income. It is at the discretion of the Trustees which beneficiaries they pay out to and in what quantities.
  4. On expiry of the trust, the capital and any accumulated income is paid to the ultimate beneficiaries who may not be the same beneficiaries as those who potentially could have benefitted during the lifetime of the trust. However, very often trusts will have appointed out all of the assets long before the expiry of the trust.
  5. Trust will be subject to exit charges and 10 yearly annual charges over and above the available NRB.
  6. Trust potentially can be brought to an end by the Trustees and distributed according to the terms of the Will (which may not be the trust beneficiaries).
  7. There will be no spouse exemption even if a spouse is a beneficiary.
  8. Any gifts into a trust or to anyone other than the testator’s spouse or that are not subject to IHT reliefs whether by Will or in the lifetime of the testator have the effect of reducing the testator’s NRB; therefore, if the gift into the trust exceeds the testator’s available NRB, there will be no transferable NRB.
  9. No transferable RNRB will be available if property assets are transferred to a discretionary trust. To benefit from the RNRB, or indeed if it is to be transferred to a surviving spouse’s estate, property must be left to a direct descendant or to the surviving spouse by way of an IIP. A property gifted to a trust, even if the beneficiaries are the testator’s spouse and direct descendants, is not deemed to be a gift to a direct descendant and therefore no RNRB or transferable RNRB will be available.
  10. Income is subject to the additional higher rate of tax – so 45% (or 39.35% if dividends).
  11. Provides some flexibility for changing tax regimes so that if all the assets are appointed out of the trust within 2 years of the date of death of the testator, then the assets for tax purposes are treated as if they were gifted by the Will such that the trust never existed. This means that the Trustees can assess the various tax regimes in place at the time and appoint out assets (or not) accordingly.

 

Flexible Life Interest Trust (FLIT)

  1. This is hybrid of an IIP and a RPT. Essentially it is a Life Interest Trust with a discretionary trust element. The Life Tenant is automatically entitled to any income generated by the trust assets or has the right to live in a property that forms part of the trust assets.
  2. Life Tenant is usually (but not always) included in the pool of discretionary beneficiaries.
  3. Whilst the Life Tenant is alive, it works almost exactly the same as an IIP except that:
    • Beneficiaries do not have a vested interest
    • Trustees automatically have the power of appointment and flexibility to make payments to the Life Tenant and other beneficiaries in such amounts and frequency at their discretion
  4. It benefits from spouse exemption (assuming Life Tenant is a spouse).
  5. As the assets in the discretionary trust are treated as having been gifted to the surviving spouse, the Nil Rate Band (if available) can be transferred to the surviving spouse’s estate.
  6. Income is taxed at the Life Tenant’s rate whilst the Life Tenant is alive, but once the Life Tenant has died, any income is charged at the additional higher rate.
  7. The value of the trust is considered against the Life Tenant’s estate for IHT purposes.
  8. Automatically converts to a full RPT on the Life Tenant’s death and all the relevant provisions to RPT’s apply.

The above does not constitute advice and if you are interested in exploring Will trusts then you should seek professional advice that is tailored to your individual circumstances.

Annelise Tyler

Annelise Tyler
Chartered Legal Executive