Get ready for a lot of acronyms…..
A Flexible Life interest trust can be included in your Will as a testamentary trust. If you don’t know what one of those is have a look here
Flexible Life Interest Trusts (FLITs) are sometimes described as “the ideal modern family trust”, so they are considerably better than they sound! The reason for this is that it allows a person to benefit immediately on death while at the same time protecting the assets for others like children.
A FLIT arises when a beneficiary, normally a surviving spouse, is given a life interest (remember these? You can find them here as well!) in your assets. The trustees have the power to pay income and capital to that person.
These types of trusts are therefore very flexible and ideal where the testator ( the person making the Will ), wants to provide for their surviving partner during their lifetime whilst offering ongoing protection for others.
How does a FLIT work?
On death, the estate is put into trust. The life tenant (normally the spouse or partner) will be entitled to receive all income of the trust during their lifetime and will be treated as the main beneficiary. Trustees will have discretion with regards to capital which can be given or loaned to the life tenant.
The flexibility of giving or lending capital does not extend to just the life tenant but the other beneficiaries as well. For example, the trustees could exercise their discretion to use some of the trust funds to pay off a child’s mortgage if they asked.
Given the flexibility of this trust, where the testator would like the trust funds to be treated in a certain way, or have concerns that they would like them to be aware of, this can be set out in a letter of wishes.
Advantages of a FLIT
- Ideal for protecting the assets of the estate on the first death of a couple, but also on second death as the trust turns into a discretionary trust and can therefore benefit future generations.
- Protects the estate in the event the surviving spouse goes into care or bankrupt as the assets are owned by the trust and not the surviving spouse. The trust also protects the assets from passing to a new spouse by either being gifted to them, as part of divorce proceedings or being left to the new spouse by Will or intestacy (dying without a Will).
- The assets are protected for the benefit of the other beneficiaries from third-party claims as the trust turns into a discretionary trust and therefore the assets still belong to the trust and not the individual beneficiaries.
- Where Inheritance Tax is an issue, the trustees can loan the money so it does not have any effect on the size of the beneficiaries estate.
- The FLIT allows for the trustees to convert some or all of the trust fund into another type of trust. So if Inheritance Tax laws change in the future, the trustees can change how the fund is held. The trustees could choose to end the trust early and distribute the assets to the beneficiaries if they wish to.
Disadvantages of a FLIT
The main disadvantage of a FLIT is the future Inheritance Tax liability that this creates since assets in the FLIT would be treated as part of the life tenant’s estate for Inheritance Tax purposes.
What happens when the life tenant dies?
On the death of the life tenant, the trust will end and it will automatically become a discretionary trust.
How is a FLIT taxed?
Inheritance Tax
For inheritance tax (IHT) purposes, the life tenant of the trust is treated as inheriting the trust assets on the death of the testator.
If the life tenant is the deceased’s surviving spouse or civil partner, the spousal exemption will apply and there will be no IHT due when the assets pass to the FLIT. This means the Nil Rate Band will not be used and can be transferred to the surviving spouse so it can be used on second death.
During the life of the life tenant, no anniversary and exit charges will apply.
Whilst the life tenant is alive, the trustees and life tenant may make some gifts from the trust to other beneficiaries to mitigate IHT. These gifts will be considered as Potentially Exempt Transfers (PETS) and therefore the 7 year rule will apply for it to not form part of the life tenant’s estate for IHT purposes.
On the death of the life tenant, the trust becomes a discretionary trust which means anniversary and exit charges may apply.
Availability of RNRB
Where a main residence is left to a FLIT, the Residential Nil Rate Band (RNRB) will not be available as on second death the assets pass to a discretionary trust and not to direct descendants absolutely. A Property Trust could be used to retain the RNRB and deal specifically with any property, have a look here
If you would like to know more about including a trust in your Will, or would just like a game of acronym bingo, please get in touch.