An Interest in Possession Trust is a type of trust commonly used in the UK to provide an individual (referred to as the “life tenant”) with the right to receive income or use assets held in trust for a set period or for the remainder of their life. These trusts are frequently established to manage family wealth, ensure that income is provided to a particular individual, or control the distribution of assets over time.
Understanding how an interest in possession trust works can be particularly useful if you’re looking to set one up as part of your estate planning. In this guide, we’ll break down the basics of what an interest in possession trust is, how it works, the tax implications, and why legal advice is crucial when setting one up.
At Blackstone Solicitors, we provide expert guidance on creating interest in possession trusts for clients across England and Wales. This guide will help you understand whether an interest in possession trust could be the right option for you or your family.
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What Is an Interest in Possession Trust?
An Interest in Possession Trust is a legal arrangement where one person, known as the life tenant (or income beneficiary), has the right to benefit from the income or use of assets held in the trust during their lifetime or for a specified period. However, the life tenant does not have access to the capital or the assets themselves — these are preserved for the remaindermen (or capital beneficiaries), who will eventually receive them upon the death of the life tenant or when the trust ends.
This type of trust is often used to manage assets for multiple beneficiaries across different generations. For example, an individual might want to provide income for their spouse during their lifetime, while ensuring that the assets themselves are passed on to their children upon the spouse’s death.
Key Features of an Interest in Possession Trust
- Life Tenant’s Right to Income: The life tenant has the right to receive income generated by the assets in the trust (e.g., rental income or dividends from shares) or to use specific assets, such as living in a property held by the trust.
- Capital Beneficiaries: The remaindermen are the individuals or entities who will inherit the capital or assets of the trust once the life tenant’s interest ends (usually upon death). These are often the life tenant’s children or other family members.
- Trustees’ Role: The trustees manage the assets in the trust, ensuring that the life tenant receives the income or benefit they are entitled to, and that the capital is protected for the remaindermen. Trustees have a legal duty to act in the best interests of both the life tenant and the remaindermen.
How Does an Interest in Possession Trust Work?
An interest in possession trust is typically established in a will or through a trust deed. Here’s a step-by-step overview of how it operates:
- Setting Up the Trust: The person creating the trust (the settlor) transfers ownership of assets (such as property, shares, or cash) to the trust. This can be done during the settlor’s lifetime or upon their death through their will.
- Appointing Trustees: The settlor appoints trustees to manage the trust. The trustees are responsible for ensuring the assets are properly maintained, the life tenant receives the income or benefit, and the capital is preserved for the remaindermen.
- Life Tenant Receives Income: The life tenant has a right to the income generated by the assets in the trust. For example, if the trust holds an investment portfolio, the life tenant may receive the interest or dividends. If the trust holds property, the life tenant may live in it rent-free or receive rental income if it is let out.
- Capital Beneficiaries Inherit: When the life tenant dies or the trust’s term ends, the remaindermen (capital beneficiaries) inherit the assets held in the trust. The trustees then transfer ownership of the assets to the capital beneficiaries.
Common Uses of Interest in Possession Trusts
Interest in possession trusts are versatile and can be used in various situations, including:
- Providing for a Spouse or Partner: These trusts are often set up in a will to ensure that a spouse or partner is provided for after the settlor’s death, while protecting the family wealth for children or other relatives.
- Managing Family Assets: Families with significant assets may use interest in possession trusts to control how their wealth is distributed over time. For example, the trust might allow a family member to live in a family home or receive income from investments, with the intention that the capital will eventually pass to the next generation.
- Tax Planning: Interest in possession trusts can play a role in inheritance tax (IHT) planning. By placing assets in trust, the settlor can manage their estate in a way that may reduce the potential inheritance tax burden on their heirs. However, tax laws around trusts can be complex, so professional advice is essential.
Tax Implications of an Interest in Possession Trust
Taxation of interest in possession trusts can be complex, and it’s important to understand the different tax liabilities for the trust, the life tenant, and the capital beneficiaries.
- Income Tax
The life tenant is responsible for paying income tax on the income they receive from the trust. This income is taxed as if the life tenant owned the assets outright. Trustees must ensure that income tax is deducted at source before passing it on to the life tenant.
- Basic rate taxpayers: If the life tenant is a basic rate taxpayer, the tax deducted from the trust income should generally cover their tax liability.
- Higher or additional rate taxpayers: If the life tenant is in a higher tax bracket, they may have to pay additional tax on the trust income.
- Capital Gains Tax (CGT)
Trustees may also be liable for capital gains tax when they sell or transfer assets within the trust. However, certain exemptions and reliefs may apply, particularly for main residences.
- Trustees’ CGT liability: Trustees are responsible for paying any CGT due on gains made from the sale of trust assets, usually at a rate lower than individual taxpayers.
- Holdover relief: In some cases, trustees can claim holdover relief to defer CGT until the remaindermen take ownership of the assets.
IHT can be one of the more complex aspects of interest in possession trusts. When the life tenant passes away, the value of the trust’s assets may be included in their estate for inheritance tax purposes, which could result in a significant tax bill.
- Ten-Year Charge: For trusts set up after 22 March 2006, there may be a 10-year charge, where IHT is payable every 10 years on the value of the trust’s assets above the IHT threshold.
- Exit Charges: When assets are transferred out of the trust, such as when the life tenant dies, there may also be exit charges. These taxes are typically based on the value of the trust’s assets.
Given the complex tax rules surrounding trusts, it’s essential to seek expert legal and financial advice to ensure that the trust is structured in the most tax-efficient way possible.
Why Consider an Interest in Possession Trust?
Interest in possession trusts are a useful tool in estate and tax planning for UK residents, particularly those with substantial assets or complex family arrangements. The key benefits of setting up this type of trust include:
- Providing for a loved one: It ensures that an individual, such as a spouse, receives income or benefits during their lifetime, while protecting the underlying capital for other beneficiaries.
- Control over asset distribution: It allows the settlor to dictate how and when beneficiaries receive their inheritance, helping to manage wealth across generations.
- Tax management: In certain cases, these trusts can be used as part of a strategy to reduce or delay inheritance tax liabilities.
Do You Need Legal Advice to Set Up an Interest in Possession Trust?
Setting up an interest in possession trust requires careful planning and legal documentation, particularly when considering the potential tax implications. At Blackstone Solicitors, we have extensive experience in trust law and can help guide you through the process of establishing a trust that meets your family’s needs.
By working with experienced solicitors, you can ensure that the trust is properly structured, complies with all relevant laws, and operates in the most tax-efficient way possible.
Conclusion
An interest in possession trust offers a flexible and secure way to manage assets, provide for loved ones, and control the distribution of wealth. However, setting one up requires careful planning, particularly around tax and legal issues. At Blackstone Solicitors, we can provide expert guidance to help you establish an interest in possession trust that meets your specific needs, ensuring that your family’s financial future is protected.
If you’re considering setting up an interest in possession trust, or if you have any questions about the process, our team of legal experts is here to assist. Contact us today to learn more.
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It is important for you to be well informed about the issues and possible implications of dealing with trusts. However, expert legal support is crucial in terms of ensuring a positive outcome to your case.
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Disclaimer: This article provides general information only and does not constitute legal advice on any individual circumstances.
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