Laura Stafford
Solicitor & Head of Private Client
Phone: 0113 200 7480
Email: ls@averywalters.com
Our Private Client specialist’s guide to Flexible Lifetime Interest Trusts
Dealing with your estate and planning for the future and for tax mitigation can be stressful and confusing especially as there are a wide range of options which are available to you to arrange your estate.
Trusts are just one option, and Flexible Lifetime interest trusts (FLITS) are one of many types of trust that you can make.
This guide will help you to understand (FLIT) trusts.
What is a FLIT trust?
A flexible lifetime can offer protection against your estate.
The main feature of a FLIT is that it protects the assets you place into trust which could be your property, but also other assets held in your sole name.
With this type of trust, you elect someone to benefit from the trust during their lifetime as well as protecting the capital of the asset for your chosen beneficiaries after their death.
The individual that you select to receive the life interest is known as the ‘life tenant’ and they will benefit from any interest that the asset accumulates during their lifetime (i.e., right to life in property, rental income, interest from accounts). The beneficiaries will then receive the capital of the asset once the life tenant has passed or their entitlement period has ended.
This is a good way of reducing your estate as the asset falls under the life tenant’s estate when they die as opposed to your own, reducing your estate for inheritance tax purposes, as long as you live 7 years from making the transfer into trust.
However, the life tenant will have no control over who is to inherit the asset as it will automatically pass to the beneficiaries that you elect under the terms of the trust.
How is a FLIT set up?
A FLIT instrument can be set up in your lifetime in writing. This is signed by you as the ‘settlor’ i.e. the person ‘setting up’ the trust.
This trust instrument will contain all of the terms of the trust i.e., the potential beneficiaries, default provisions and what the trustees can and cannot do. It will also stipulate who the trustees are and set out how other trustees can be appointed.
Legal documentation will then be drawn up to transfer your chosen assets into the trust i.e., a stock transfer form for share, land registry paperwork for any property etc.
A letter of wishes should also be prepared.
What is the significance of a Letter of Wishes?
It is advisable to prepare a Letter of Wishes for your trustees when setting up FLIT.
This Letter of Wishes is not legally binding, and the trustees are not required to follow this. However, it provides some guidance and an explanation of your intentions for the use of the trust funds.
Letters of Wishes are usually private and confidential between you and your trustees but in some cases are disclosed to beneficiaries.
What are the benefits of this type of trust?
• Life interest trusts are a way to attempt to ensure assets are not used for long-term care fees.
• Assets are protected from your financial issues or any future divorce/separation.
• Assets in trust already legally vest in your trustees’ names and therefore may mean probate is not needed for your estate.
• In respect of a property, your trustees could be legally responsible for maintaining and insuring the property which could assist in old age.
• Protects assets long term for future generations.
• Could mitigate your estate for inheritance tax purposes if you are not a beneficiary.
What are the tax implications?
FLITs generally fall into the ‘relevant property regime’ which applies special rates of tax.
Relevant property includes assets such as property, money, and shares.
Entry charges
If you make a gift into a trust during your lifetime and the open market value of the gift exceeds the ‘nil rate band’, which is currently £325,000, then you will have to pay Inheritance Tax at 20% on anything above the nil rate band. You must be aware that any gifts or transfers made in the previous 7 years will reduce the available nil rate band. If the tax is to be paid by you, and not deducted from the assets being transferred into the trust, grossing up applies and the rate of tax will be 25%.
If you die within 7 years of making a transfer into a discretionary trust, any Inheritance Tax charges will be recalculated at the death rate. The tax will also be subject to a relief, known as ‘taper relief’ which begins 3 years after the transfer and reduces the amount of tax to pay every year that passes.
A periodic charge
Every 10 years, the value of the trust fund is taxed at a maximum rate of 6%. This is payable by the trustees out of the trust fund.
When the trust is created the 10-year periods are automatically counted. If the assets are not relevant property for the full period, then this charge is reduced.
Exit charges
An exit charge is applied over any reduction in the value of the trust fund, for example when assets are distributed to the beneficiaries. The exit charge is proportional to the number of quarter years that have passed in the current 10-year period.
An exit charge may also apply in situations where the assets no longer fall under the relevant property regime.
The exit charge rate is taxed at a maximum rate of 6%.
Capital Gains Tax
When a lifetime trust is created, any assets transferred into the trust may be subject to capital gains tax, payable by the creator of the trust. This is because it is treated as a disposal of an asset, so if the value of the asset at the time of the disposal is more than what it was acquired for, capital gains tax may be payable.
Capital gains tax may also be payable when the beneficiaries become entitled to the asset in the trust as this would also be treated as a disposal of an asset. The market value of any assets will be reviewed, and any gain will result in capital gains tax being made payable.
Holdover relief may apply.
Income Tax
The income received by the life tenant must be calculated along with their personal income, which may result in income tax being payable on the trust income.
IHT mitigation- What if I am the beneficiary?
If you are the life tenant, i.e. continue to live in the property after it is gifted into trust, then for inheritance tax purposes you will still be deemed to own the property. This is called a ‘gift with reservation of benefit’.
If you choose to do this, you will have to consider that you are setting the trust up for the right reasons, and not to deprive the local authority of fees, for say care home fee payments. We can provide you with further advice about this.
Are there any downsides to doing this?
The downside to this arrangement is that it is restrictive for the life tenant who would need to request funds from the trustees each time they are required.
There is also a substantial burden placed on the trustees to administer and manage the trust, especially if they are lay trustees i.e., friends or family members as opposed to professionals.
The management and running of a trust can also be costly and complex and it is common that professional assistance is required from a solicitor or accountant.
What responsibilities do my trustees have?
Trustees should meet at least annually to consider making distributions from the estate.
They should also do the following: -
• Prepare and keep accounts.
• Annual tax returns
• Take financial and legal advice
• Ensuring the trust is registered with HMRC
Can the trust be brought to an end?
There are usually flexible powers contained in FLITs to allow the trustees to bring the trust to an end by giving all the assets to the potential beneficiaries.
If the funds run out, then the trust would also come to an end.
There may also be powers within the trust to allow the trustees to transfer the funds into a different trust on different terms.
The maximum length of time that the trust can run is 125 years. At this point, any funds remaining would be distributed to default beneficiaries set out in the trust instrument.
* Laura Stafford is the SFE accredited memberand a full member of STEP