Flexible Life Interest Trust
Due to more complex estates and greater wealth, greater flexibility is essential to cope with any future changes to the family structure (such as new family members) and changes in the tax regime. The best way to gain the maximum flexibility is by the use of a Flexible Life Interest Trust (FLIT).
How a FLIT works
The residue of the estate is held on trust for the surviving spouse or civil partner for their lifetime, after which or when the life interest is ended, a discretionary trust will arise in favour of nominated beneficiaries, usually children and issue.
Trustees are given a number of powers. They can grant the income of the trust fund to the surviving spouse/civil partner and have the power to grant the capital of the trust fund to them as either absolutely or as a loan, which would be repaid when the spouse dies or goes into care. The power to give the capital absolutely is unlikely to be used as this would mean the trust fund would now be owned by the surviving spouse and can be gifted away to a new spouse or assessed in divorced proceedings or by a Local Authority for care fees. Nevertheless as the trust is intended to be flexible, this power does allow the trust to be wound up and all the capital granted to the spouse.
The power to pay income or capital or loan capital applies equally to nominated beneficiaries. For example, if the spouse does not need the capital, as they are now in a care home, but the child does, as they wish to pay off their mortgage, capital could be paid to them instead.
A FLIT in favour of a surviving spouse or civil partner will utilise the transferable nil rate band. For IHT purposes, it is treated as an outright gift to the surviving spouse and so is not taxed and does not use any of the IHT allowance for the deceased spouse. The FLIT will instead preserve it for the death of the surviving spouse.
Due to the nature of this Trust, there are no Anniversary or Exit charges to pay. The life tenant can take advantage of this by making gifts during their lifetime in order to mitigate IHT.
A FLIT will ensure that the trust fund eventually goes into the names of the nominated beneficiaries. In the event of the surviving spouse going into care or going bankrupt, the trust fund is protected from the claims of creditors and Local Authorities as it they only have a life interest in the fund and it is not owned by them. It is similarly protected from falling into the pockets of a new spouse by either being gifted to them, by being involved in divorce proceedings or by being left to the new spouse by will.
The nominated beneficiaries are equally protected from claims these claims once the life interest converts into a discretionary trust. The fund is not owned by them, they only have a chance of gaining an interest in it.
The trust includes a power for the trustees to convert some or all of the trust fund into another type of trust. So if IHT laws change in the future and make it more tax efficient for the fund to be in a different trust, such as a Nil Rate Band Discretionary Trust, the trustees will be able to make that change.
Some of the named beneficiaries may already have assets exceeding the nil rate band. In such a case rather than the capital being given to them, the trustees could instead loan to them or make occasional benefits once the discretionary trust arises. Alternatively others may wish simply to receive their share of the funds, in which case the trustees have the power to advance the capital.
Whilst the disadvantages are minimum, there are a few;
- Because the assets held in the Trust are treated as if they belong to the life tenant of the Trust for IHT, they are taxed at 40% on their deaths before the assets pass solely into the Discretionary Trust. Because of this, due to the Transferable Nil-Rate Band this Trust is most beneficial from spouse to spouse.
- Because the Trust allows the Trustees to advance income and capital, the whole use of the assets held by the Trust could be used up during the lifetime of the life tenant, leaving nothing for the discretionary beneficiaries to benefit from.
- If during the lifetime of the life tenant they decide to dismantle the Trust, this is considered making a PET (Potentially Exempt Transfer) for IHT purposes, therefore must survive 7 years for the assets to no longer be considered as part of their estate.