How can you best protect the value your property after death? Susan Young of Birketts LLP discusses the benefits of including a life interest trust in your will.

How can I protect the value of my property in a will?

With property prices ever increasing, a home is often the largest asset included in a will. Therefore, when writing a will, an important consideration will be how best to protect the value of your property for future generations, with questions including:

• Should I simply leave all the estate to my spouse, hoping they won’t alter my will and ignore my wishes?
• Should I pass the property to my children immediately, either in whole or part?
• If I do pass the property to my children, where will my spouse or partner live?

It’s because of these considerations that one of the most common ways of providing a layer of protection for a home is including a ‘life interest trust’ in a will.

What is a life interest trust?

A life interest trust enables the person making a will (testator) to preserve the value of their estate for future generations, either in relation to only the property or the property and wider assets.

With a life interest trust, a property could be let and provide a stream of income for the initial beneficiary, which is often the surviving spouse or partner. This beneficiary is what is known as the life tenant. A life tenant is entitled to the income from the assets within the trust, known as a trust fund, during his or her lifetime or until the trust comes to an earlier end.

Depending on the underlying assets within the trust fund, the life tenant can:

• receive income from dividends, rent or bank interest
• live in the property rent free

After the death of the life tenant (or earlier termination of the trust), the remaining capital of the trust fund can then be passed on to other individuals, known as the remaindermen, or a separate trust, as set out in the will. As such, the capital value of the trust fund is preserved for the remaindermen while also enabling the life tenant to receive income.

Additionally, the trustees of the trust fund (chosen by the testator and possibly including the surviving spouse or partner) can be given the ability to advance capital to the surviving spouse or partner if it is needed. This can also be extended to enable capital to be advanced to the remaindermen or other potential beneficiaries during the life tenant’s lifetime, which can have its own inheritance tax benefits.

When should you include a life interest trust in a will?

The main reason life interest trusts are included in wills is for the preservation of the capital value of a property. This means that life interest trusts are commonly used when:

• there are second relationships, with children from the first. As such, the testator can ensure their share in the property passes to their children on the second death.
• there are concerns that the survivor may remarry and subsequently divorce, meaning assets may be divided between the survivor and the new spouse, reducing the value to pass to the children.
• there are concerns with care fees and wanting to preserve capital to pass to the younger generations.

What are ‘tenants in common’ and ‘joint tenants’ in a life interest trust?

When including a life interest trust in a will, a will drafter will need to ensure the property is held as tenants in common where a property is jointly owned with one or more other people. This means that the deceased’s share can pass under the will and into the trust. If the property is held as joint tenants, it will simply pass to the survivor on the first death and will not be capable of passing into the trust.

However, in the circumstances where this step has been missed, or for some other reason the property has come to be held as a joint tenancy by the date of death, it is possible for the survivor to retrospectively enter a ‘deed of variation’ to sever the joint tenancy.

Are there any inheritance tax implications when using a life interest trust?

Implications for surviving spouse

Any assets passing to a surviving spouse on the first death are treated as exempt from inheritance tax and this remains the case even where the assets pass on a life interest trust for the spouse’s benefit. A life interest trust is therefore tax neutral from this perspective.

However, the value in the trust will still be treated as being part of the survivor’s estate on his or her subsequent death and will be subject to inheritance tax at that point, with any inheritance tax due apportioned pro rata between the trust and the survivor’s other assets.

Implications for others

If the life interest trust is set up for someone other than a surviving spouse, it will potentially be subject to inheritance tax on both the first death and the second death. This should always be carefully discussed with professional advisers, as you may still wish to incorporate such a trust, preferring the protection it affords despite its inheritance tax implications.

Alternatively, a more flexible discretionary trust might be appropriate, though it would be subject to the relevant property regime, with the accompanying ten yearly charges and exit charges, instead of being taxed on the death of the partner.

It should also be noted that if the trustees have been given the power to appoint capital to someone other than the surviving spouse or partner during their lifetime, then any such appointment is treated as a ‘potentially exempt transfer’ by that individual. This means that the survivor must survive that transfer by seven years (under the current regulations) for the gift to fall outside of his or her estate for inheritance tax purposes.

What is residence nil rate band (RNRB)?

An estate may be entitled to residence nil rate band (RNRB) before any Inheritance Tax is due if their estate is worth more than the basic Inheritance Tax threshold. RNRB is complex but applies if the deceased’s estate meets with the statutory requirements, which are:

• The deceased dies on or after 6 April 2017.
• The estate is valued at less than an upper limit (presently £2 million). If the estate is over this sum taper applies to the RNRB.
• The deceased’s home, or one of them, or part of one or them, is left to qualifying beneficiaries, ie direct descendants.

For deaths in the current tax year, the maximum available amount of RNRB rate is £150,000 per qualifying estate (£175,000 from April 2020). Any unused allowance is capable of being claimed by the second spouse, so long as his or her estate again meets the requirements.

Utilising a life interest trust in wills for spouses will therefore mean that this allowance is transferable to the survivor on the second death, provided the property or a suitable part of it passes then outright to lineal descendants of the original testator.

Should I use a life interest trust?

A life interest trust is often an appropriate structure for those preparing a will, but it is important that the testator’s objectives, assets in question and estate planning more generally are considered before taking the decision. It is therefore important to seek professional advice, so you can make a fully informed decision as to how your wishes may be fulfilled after death.

About the author

Susan Young is a Senior Associate at Birketts LLP and deals with UK succession and tax planning, involving wills, trusts, probate applications, powers of attorney and deputyships.

See also

Jointly-owned property on death

What happens to a joint bank account when someone dies?

Everything you need to know about will trusts

Find out more

How to apply the residence nil rate band for Inheritance Tax (Gov.uk)

Inheritance Tax (Gov.uk)

Image: Getty Images

Publication date: 27 February 2020