If you are considering setting up a trust, there are various types of trust to choose from. In the case of an interest in possession trust, the beneficiary has right to receive the income from the trust at any time they choose, without having a right to assets themselves.
So what is an interest in possession trust, and when might you choose to use one?
What is an interest in possession trust?
An Interest in Possession Trust is one which grants the beneficiary (the person who benefits from the trust) an immediate and automatic right to receive income from the trust. As with other trusts, there are trustees assigned to manage the trust on behalf of the beneficiary, so that the beneficiary does not have legal control over the assets. However, unlike in a discretionary trust, the trustees of an interest in possession trust are obliged to pay out all income immediately to the beneficiary, aside from any trust expenses that they need to deduct.
There are two different types of beneficiary in an Interest in Possession trust:
1. The “life tenant” or “income beneficiary”
This is the beneficiary who has a right to the income or enjoyment of the trust throughout their lifetime, or until certain conditions, set out by the creator of the trust, are met. In some cases the benefit of the trust may not be financial – for example, it may be the right to continue living in a house for the rest of their life. However, whilst income beneficiaries are entitled to the benefits of the trust, they have no rights to the capital or assets themselves. There can be more than one income beneficiary, but all of the income during the lifetime tenancy is paid to the income beneficiaries alone, excluding any other beneficiaries (i.e. capital beneficiaries).
2. The “remainderman” or “capital beneficiary”
The second beneficiary is the one who will eventually receive the asset or capital in the trust, once the “interest in possession” has ended. They have no rights to any of the income from the trust until after the “interest in possession” has concluded.
For example:
Simon is married to Emily, but has two daughters from a previous marriage.
In his will, he establishes a trust fund containing all of his shares.
Emily is the life tenant of the trust, so she will receive all dividends from the shares during her lifetime.
After Emily’s death, the trust ends and ownership of the shares will pass to Simon’s daughters, who are the capital beneficiaries
Why use an interest in possession trust?
There are many reasons why you may choose to set up a trust, and interest in possession trusts offer some flexibility in how you pass on your estate.
In particular, interest in possession trusts are helpful for those who wish their children to inherit their estate, but want to allow their spouse or civil partner to continue living in the family home until they pass. The children still inherit the property through the trust, but not until after the death of the surviving spouse.
What are the tax implications of an interest in possession trust?
It is the responsibility of the trustees to declare and pay any Income Tax annually through a Trust and Estate Tax return. That said, trustees sometimes “mandate” income to the beneficiary, meaning income goes directly to the beneficiary rather than via the trustees. In this case, the beneficiary must include it on their own self-assessment tax return. The income tax rates for interest in possession trusts are as follows[1]:
Dividend-type income = 7.5%
All other income = 20%
Capital Gains Tax is due on any profits made through a sale or transfer of assets – such as shares, possessions or property – when those assets have increased in value. It is only paid on any gain over the trust’s Annual Exempt Amount. However, Capital Gains Tax is not payable when assets are passed to the remainderman at the end of the “interest in possession”.[2] The beneficiaries of an interest in possession trust are not taxed on the trust gains.
It is worth noting that, depending
on the date at which assets were transferred into the trust, inheritance tax
may be payable. This could be charged when assets are transferred into the
trust, when the trust reaches its 10 year anniversary, or when the assets are
distributed from the trust.
The contents of this article do not constitute legal advice and are provided for general information purposes only.
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[1] https://www.gov.uk/trusts-taxes/trusts-and-income-tax
[2] https://www.gov.uk/trusts-taxes/trusts-and-capital-gains-tax