Interest in possession trusts: at a glance
What do I need to know? Interest in possession trusts can give you more control over how you pass wealth and assets to loved ones in certain circumstances.
What does it mean for me? You can give a beneficiary income for life through an interest in possession trust while preserving your assets for future generations, depending on how you set it up.
Why does it matter? Trusts can be complicated, so it’s essential to understand how they work before you commit to opening one.
Interest in possession (IIP) trusts can be a useful wealth and estate planning tool, allowing you to pass wealth to multiple generations through a single trust.
In this guide, you’ll learn what an IIP is, how it works, the tax implications, and how it can fit into your wider wealth strategy.
What is an interest in possession trust?
An interest in possession trust, also known as a life interest trust, lets you nominate a ‘life tenant’ (or a ‘life renter’ in Scotland) to receive income generated by the trust assets during their lifetime.
When they pass away, the assets can transfer ownership to the ‘remaindermen’ or ‘remainder beneficiaries’, depending on the terms of the trust.
The roles within an interest in possession trust
IIPs involve four key roles, from creating and managing the trust to benefiting from its assets:
Settlor: the creator of the trust
Trustee: the manager of the trust
Life tenant: the recipient of income generated from the trust during their lifetime
Remaindermen: the beneficiaries when the life tenant passes away
Who uses interest in possession trusts?
IIP trusts are commonly used by people with blended families. For example, if you have children from a previous relationship, an IIP trust could balance your desire to provide for your current spouse and pass wealth on to your children.
Your spouse can benefit from the trust during their lifetime, and your children could inherit the trust’s assets in the future.
Interest in possession trusts are often designed to help you balance the interests of current and future beneficiaries.
How do interest in possession trusts work?
Unlike other trust structures, an interest in possession trust has two types of beneficiaries. The first is the life tenant, who is entitled to receive income from the trust as it arises, after expenses. But the life tenant doesn’t own the trust itself or its assets.
When the life tenant passes away, it’s possible for the remaindermen to benefit from or become entitled to the trust’s assets. But, as always, the exact outcome depends on how you set up the trust.
For example, Sarah leaves £1m in assets in an interest in possession trust. Her husband, John, is the life tenant. He receives the income generated by the trust throughout his lifetime. When John passes away, the trust’s assets pass on to Sarah’s children - the remaindermen.
Once you transfer assets into an IIP trust, they no longer legally belong to you. When the trust earns income through interest, rent, or investment profits, the life tenant is entitled to it.
The life tenant can start receiving income as soon as the trust is established or, more commonly, once the settlor passes away. The exact rules depend on the terms you outline in the trust deed.
What’s involved in setting up an interest in possession trust?
When setting up an interest in possession trust, it’s important to seek professional guidance. Trusts are complex legal arrangements, and getting the details wrong can have serious financial consequences.
Once you’ve got legal support, the first step when setting up an IIP trust is usually to identify the trustee, life tenant, and remaindermen.
You’ll also need to complete a trust deed or will, which outlines when the life tenant can start receiving income payments.
You can then transfer your desired assets into the trust as the settlor. Generally, you’ll need to register the trust with HMRC. Exact timelines and deadlines for registering your trust depend on the type and when the trust was created. There are also some circumstances where your trust may be excluded from the need to register.
Interest in possession trust tax implications
Tax implications for IIPs can be complicated. Trusts are rarely something you can set up on your own. So, it’s important to check relevant HMRC guidance and seek advice from a financial adviser to understand exactly how HMRC might tax the assets you place in a trust.
Interest in possession trusts and Inheritance Tax
IIPs have complex Inheritance Tax (IHT) rules, because the way in which HMRC taxes trusts depends on how they are structured and when they were set up.
For trusts opened before 22 March 2006 and other qualifying IIPs, HMRC will, in most cases, treat the assets as part of the life tenant’s estate for IHT purposes when they pass away. This means the value of remaining assets may be subject to IHT, with the amount depending on the estate’s value, available exemptions, nil-rate bands, allowances, and relief. Otherwise, the trust will usually fall under the ‘relevant property’ rules.
Most non-qualifying IIP trusts created on or after 22 March 2006 fall under ‘relevant property’ trust rules. This means HMRC can apply IHT charges when assets enter the trust, on each 10-year anniversary, and when assets leave the trust.
Interest in possession trusts and Capital Gains Tax
Trustees are generally responsible for paying Capital Gains Tax (CGT) when it needs to be paid. This can happen when trustees dispose of an asset held in a trust or transfer assets in or out of an IIP. The rules are complicated and the exact taxes you need to pay can depend on how you set up the trust.
There is usually no CGT due when the life tenant passes away. For qualifying IIP trusts, HMRC typically ‘rebases’ the trust assets. This means the assets’ market value is reset at the date on which the life tenant passes away. So, any increase in value that occurred during the life tenant’s lifetime is generally not subject to CGT at that point.
Trustees may need to pay CGT on chargeable gains, after any applicable allowances or relief. Trusts also have their own annual CGT allowance, which is lower than the allowance for individuals. The rate payable can vary depending on the type of asset and the tax rules in force at the time, so it’s important to check current HMRC guidance or seek advice.
Interest in possession trusts and Income Tax
For Income Tax purposes, income from an interest in possession trust is generally treated as the life tenant’s as it arises. Trustees may have to pay Income Tax before distributing the funds, and the exact rate payable depends on the type of income.
Life tenants need to submit a tax return and declare the income they receive from the trust, paying Income Tax at their marginal rate. The taxes that have already been paid may be taken into account by HMRC. Whether or not the life tenant has additional taxes to pay depends on the kinds of income they received and their personal circumstances.
Frequently asked questions about interest in possession trusts
How do you end an interest in possession trust?
Most IIP trusts created through a will end when the life tenant passes away. At this point, all remaining trust assets pass to the remaindermen.
Alternatively, an IIP trust can also end if the life tenant chooses to surrender their right to the trust income, although this depends on the trust’s terms. HMRC treats asset transfers to the remaindermen during the life tenant’s life as a lifetime gift for IHT purposes.
This transfer could also trigger CGT, so it’s important to get qualified financial advice before you make important decisions, especially when trusts are involved.
What is the difference between an interest in possession trust and a discretionary trust?
Discretionary trusts are designed to give trustees full control over the wealth held in the trust. There is no life tenant, so trustees can distribute income and assets to beneficiaries as they see fit. The beneficiaries of a discretionary trust aren’t guaranteed entitlement to funds.
Trustees in IIP trusts generally enjoy less flexibility. They’re required to transfer all trust income to the life tenant and transfer the assets to the remaindermen once the life tenant passes away, depending on the trust’s terms.
IIP trusts and discretionary trusts also have different tax rules across Income Tax and IHT. If you’re deciding between different types of trusts, check HMRC guidance or speak to a financial adviser to find out which would be a better fit for you.
What is a remainderman in an interest in possession trust?
Remaindermen are the final beneficiaries of interest in possession trusts, eventually inheriting ownership of the assets.
Remaindermen receive the ‘remains’ of the trust’s assets and wealth after the life tenant passes away or surrenders their right to income.
What is the difference between a life interest trust and an interest in possession trust?
The terms ‘life interest trust’ and ‘interest in possession trust’ are often used interchangeably, and in most cases, they describe a similar arrangement. But the two are not always identical.
A life interest trust is a type of interest in possession trust where the beneficiary’s right to income lasts for the entirety of their life.
So, while all life interest trusts are interest in possession trusts, the reverse isn’t always true. An interest in possession trust can give someone income for a fixed period, rather than until they pass away.
Does an interest in possession trust need to be registered?
In most cases, yes, you must register an IIP trust with HMRC using the Trust Registration Service. While there may be some circumstances in which you're excluded from the need to register, these are highly specific. You can check if and when you need to register your trust on the HMRC website.
If you create an interest in possession trust through a will, registration of the trust can wait for up to two years from the date you passed away. After these two years, the lead trustee will need to register the trust. The lead trustee can be an individual, an organisation, or an agent acting on your behalf.
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