Matrix Trust & Estate Planning Service
Trust & estate planning go hand in hand when it comes to safeguarding your assets for future generations. Protective Property Trusts (PPTs) are highly recommended and widely used in wills as part of a comprehensive trust & estate planning strategy.
The PPT is specifically designed to secure the deceased’s share in their home and provide the life tenant with a lifetime interest in the property. This ensures their protection and allows them to continue living in the property until the end of their life or an earlier specified condition, such as remarriage. Importantly, the PPT also guarantees that in the event the surviving spouse requires long-term care, at least half of the property is preserved for the benefit of the beneficiaries, who are usually the deceased’s children.
These types of trusts are particularly suitable for married couples or civil partners as they ensure that the share of the home ultimately passes to the children at the conclusion of the trust period, while still protecting the interests of the surviving spouse.
For instance, let’s consider a married couple with no prior marriages who would like to leave their share of the house to their only child. Currently, they own the house as joint tenants. To implement their trust & estate planning strategy, their Estate Planning Consultant would sever the tenancy, registering each of them as 50% owners. Subsequently, they would have their wills drafted to reflect that if one spouse passes away, their half of the property would be held on Trust for the benefit of their child, while allowing the surviving spouse to reside in their share of the property for life or a specified period.
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Considering the point above with regards to severance, when considering a PPT, it is important to be able to distinguish the difference between tenants in common (TiC) and joint tenants (JT). The reason for this is that the property must be held as tenants in common to enter the trust.
What does this mean? To simplify, both TiC and JT refer to how a property is held or owned and this ‘ownership’ is registered with the Land Registry. Traditionally, when houses were purchased, the owners would have been registered as joint tenants. This would have meant that if one tenant died, the other tenant would have inherited the property by virtue of survivorship.
Holding the property as tenants in common means that each owner holds a share of the home which can be gifted via their Will. We would always advise the title is checked as there are occasions where clients may believe the home is held as tenants in common when, upon checking to verify this, the home is in fact held as joint tenants. Obtaining a copy of the title register is a small fee of £3.
The trust would be set up on the death of the first testator. The legal title will then be transferred into the joint names of the surviving spouse (as an example) and the trustees.
It is important to add here that a property cannot enter a life interest trust on death as until the mortgage has been settled, they are not seen to own the property. The simpler solution would be to ensure that both clients have life cover in place to cover the mortgage on first death. If on death there is still a mortgage on the property and there is nothing in place, the survivor does still have limited options:
The main reason for a PPT is the protection it provides for the beneficiaries i.e. the children, to ensure they are protected and ultimately receive a share of the home.
If the share of the home is simply gifted to the partner directly, this could cause a number of issues – the main one being sideways disinheritance i.e. the surviving partner remarries and the house passes to their new spouse under the Will. A PPT will enable the partner to stay in the home and will avoid the risk of the partner potentially disinheriting the children.
Likewise, if a share of the home is gifted to the children directly while the spouse or partner has the other share, this could cause issues in that the children may want to force step mum out of the property or insist that she pays rent to remain in the property. A PPT prevents this from occurring and essentially protects both parties’ interest. It is important to add the beneficiaries will only own the share of the home when the PPT ends either due to the death of the life tenant or earlier.
A PPT can include powers allowing the life tenant to downsize and use the sale proceeds to purchase a substitute property for the life tenant to live in. The additional proceeds from the sale will remain in the trust and the life tenant can be paid an income from this. This can be useful where the life tenant may not be able to look after a large home as they grow older.
If the life tenant (Mr) decides to revoke his life interest, he would simply inform the trustees that he wants the life interest to end and the share of the home will be distributed to the beneficiaries. However, if the life tenant also owns a share of the property, this does mean there is a risk that the children, now owning a share of the property, could attempt to force a sale of the property.
If the life tenant decides to revoke their life interest, as it will be earlier than death, the distribution to the beneficiaries will be classed as a Potentially Exempt Transfer (PET) from his estate and therefore he will need to survive the 7 year period for it to not form part of his estate for IHT purposes.
The main disadvantage of a PPT is that this inherently comes with a loss of control over the property for the survivor, since they’d be limited in how they manage the property e.g. would need the trustees agreement to sell, would be unable to take out equity release if needed.
Probate would be required and there would be fees associated with setting the trust up and transferring the property to the trust. Probate is unlikely to be avoided completely unless all the assets are held jointly.
There is also the future IHT liability that this creates since assets in the PPT would be treated as part of the life tenant’s estate for IHT purposes. If they had directly inherited the property, at least they could have had the opportunity to carry out some lifetime planning to reduce this.
For inheritance tax (IHT) purposes, the life tenant of the trust is treated as inheriting the trust property 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 delay any IHT until the life tenant’s death.
When the life tenant dies, everything in the PPT will be revalued and included in their estate for IHT purposes.
Where PPT’s are used between married couples or civil partners, the RNRB will apply if the share of the home passes directly to their direct descendants i.e. children.
Where there are unmarried couples it would be easier to explain using the example below:
Fred and Elsie own a property as tenants in common. They are not married. Fred has 2 children from an earlier marriage. If Fred includes a PPT in his will giving Elsie a life interest in the property until her death and names his children as the beneficiaries at the end of the trust, the RNRB will not apply. The reason for this is because the interest is seen as passing to Elsie and would therefore need to pass to her direct descendants for the RNRB to apply. If, however, Fred and Elsie get married, the RNRB will apply as stepchildren are classed as direct descendants.
There is no capital gains tax (CGT) payable on the testator’s death. The trustees will acquire the testator’s share in the property at the value at the time of death. There will be no CGT payable on the life tenant’s death.
CGT would need to be considered in the event the property is sold between the testator’s death and the life tenant’s death.
If a PPT covers the main residence, this will allow the private residence relief for CGT to apply and ensure that no CGT will be payable if the property is sold, e.g. to downsize.
Where the property is the life tenant’s main residence, the trust will not be creating any income. However, if the property is rented, cash is released due to downsizing or if the property is not the life tenant’s main residence, the trust will produce an income which will need to be taxed.
The life tenant is entitled to all income of the trust and is generally taxed on the basis that it belongs to the life tenant. However, this will depend on whether the trustees receive the income and then pay it to the life tenant or whether the trustees mandate the income so that the life tenant receives it directly. If the trustees mandate the income, it will be the responsibility of the life tenant to declare and pay the income tax due.
A discretionary trust is a type of trust where the trustees are given complete discretion to pay or apply the income or capital of the assets for the benefit of one or all of the beneficiaries. They have control over how much to distribute at any given time, when to make distributions and who to make them to. No particular beneficiary has an interest in the trust or an entitlement to the trust funds – they only have a potential interest until the trustees actually exercise their discretion in their favour.
As the trustees have complete discretion over the trust funds, it is advisable for the testator to write a letter of wishes accompanying the Will which provides some guidance to the trustees in how they would like the assets to be distributed. It is important to note that letters of wishes are not a legally binding document and therefore there is no obligation placed on the trustees to follow them.
The aim of this type of trust is to provide flexibility. This could mean that trustees have the flexibility to adapt the money paid to beneficiaries in accordance with their changing needs etc.
What are the benefits of this type of trust?
Taking each point above in turn, some beneficiaries may not be trusted to manage large inheritances and the testator may be worried that it will all be spent at once. The benefit of using a discretionary trust here is that the trustees will manage the fund, giving money to the beneficiary as and when they will require it and can essentially drip feed funds. Let us not forget the trustees do have complete discretion, so if a beneficiary with spending habits wants to purchase a top of the range sports car, the trustees are well within their remit to refuse this request.
Holding funds in the trust will also protect the money from the beneficiary’s creditors or potential bankruptcy. It is also useful where the beneficiary has a drink, drug or gambling problem and the testator does not want to gift the monies to them directly for fear it could exacerbate their addiction.
A discretionary trust can be used to ensure agricultural property relief or business property relief is used.
A discretionary trust can also be used to preserve funds for a minor until they attain an age where they can manage the money for themselves, or to protect funds for beneficiaries beyond their age of majority – even if there are no concerns of addiction. Some beneficiaries may have already reached the IHT threshold and do not want the inheritance they are to receive to increase the size of their own estate. In this situation, the trustees could simply lend the money to the beneficiary.
These types of trusts are also commonly used by those looking to drip feed money to vulnerable beneficiaries to avoid them from losing any benefits they are entitled to.
Lastly, it can be used to safeguard money from a beneficiary that is going through a divorce. The benefit of entering their share of the estate in this trust is that the trust funds will not be treated as belonging to the beneficiary as the trust owns the assets and will therefore fall outside of the beneficiary’s estate.
It is important to remember that a discretionary trust requires a minimum of two beneficiaries due to the discretionary factor the trustees have. Beneficiaries can either be individuals or classes i.e. “my children.”
A discretionary trust can last for a maximum of 125 years; therefore, it is important to consider who the default beneficiaries will be i.e. those who will inherit the trust fund when the trust fund ends. The trust can end earlier in instances where all of the beneficiaries have died, or if the trustees have decided to wind down the trust and distribute the trust assets accordingly.
A discretionary trust is subject to the relevant property regime. Therefore, if the funds in the trust exceed the nil rate band, anniversary and exit charges will apply.
It is important to note that where a main residence passes to a discretionary trust, the RNRB will not apply. However, the RNRB could be recovered if the property is appointed out to direct descendants within 2 years of the testator’s date of death due to section 144 of the Inheritance Act 1984. However, this is likely to cause extra expense to the estate so we would advise the main residence is addressed separately in the Will.
A tragically common occurrence is one where a testator (the person whose Will it is) has a dependant that is vulnerable in nature, often unable to manage money or themselves through no fault of their own.
This is where Vulnerable Person Trusts (VPTs) come into to save the day and ensure that those we leave behind that are unable to care for themselves are cared for by the finances in our estate. VPTs act much like a Discretionary Trust (DT) does, where you can appoint a trustee (the one in charge of administering the Trust) with finances being held by the Trustees (which could be family members, carers etc) that could utilise the money to fund care for the person in question.
Care doesn’t strictly have to come in the form of cash, this advice also goes for the trustees who are managing the funds for the primary beneficiary (the vulnerable person benefiting from the VPT). Everybody is different and have their own way of going about their life, this is no different for vulnerable beneficiaries, it is merely a matter of ability and adjusting to suit their needs.
Say there is an individual who does not have a concept of money, they are unable to recognise its value, but they are still capable of shopping and feeding themselves. A VPT could dispense value to the beneficiary in the form of supermarket vouchers as an example as these can often have the benefit in being limited to what can be purchased with said vouchers, or by paying for services.
The money is managed by a Trustee, they use their best judgement to assess the best way for the funds to provide a benefit for the beneficiary, there is an amazing deal of flexibility in these trusts while staying very strict to ensure the vulnerable beneficiary is protected.
VPTs provide not only the flexibility of a discretionary trust when it comes to controlling the flow of the benefit, but also allows protection not afforded by a regular discretionary trust as other beneficiaries are limited to their entitlement. Anyone who is classified as a beneficiary under this trust but is not the primary beneficiary would be limited to receiving 3% of the trust/ £3000 (whichever is lower) per tax year between them; usually this would be siblings of the vulnerable person or descendants.
This ensures that the primary beneficiary is to receive the main bulk of the trust, giving it the distinct advantage over other types of trusts where a testator may be worried about their money not going where they would like it to go after their death as seen in regular DTs.
Following this, a VPT also provides more favourable tax benefits by having no increased tax liability when it comes to gifting money out of the trust. DTs have a charge up to 6% per exit and a periodic charge of 6% every 10 years for the value over £325,000 (this first £325k of their whole estate being tax free).
While I appreciate that many people do not have £325,000 to put into a trust, this is by no means a financial requirement. The special inheritance tax treatment of this trust is simply an additional benefit.
One thing extra to consider is whether the principal beneficiary of the trust is a “lineal” descendant of the testator as this would allow for further protection from IHT for the testator via utilisation of their Residential Nil Rate Band (RBRB); we have written an article explaining how this works her if you’d like to learn more about RNRB.
So how do we qualify someone as a “vulnerable person” when assessing whether they qualify for a trust as crucial as this?
Legislation has made it flexible enough to encompass those who really need it while ensuring it is specific enough not to be abused. A vulnerable person whom this trust would be set up for will need to meet one of the requirements set out in (Section 89(4A), Inheritance Tax Act 1984 and section 38 and Schedule 1A, Finance Act 2005 (FA 2005).
We need to consider whether the individual fits any of the below categories:
(ca) a person in receipt of disability assistance for children and young people by virtue of entitlement to—
While this list above is not a fully extensive list, it gives a broad understanding of who can generally qualify for this type of Trust.
So, considering the very brief explanation above, do you see how the couple from the beginning of this article would have been able to take care of their son?
By using a VPT, they could have left him everything with someone they trust to manage his inheritance to best suit his needs!
If you feel that this is something that would be useful for your family or a friend who doesn’t quite know what to do about leaving a legacy for their vulnerable family, please ask them to reach out to a Will Writer that will be able to help them plan for this!
Flexible Life Interest Trusts (FLITs) are sometimes described as “the ideal modern family trust.” The reason for this is because it allows a person to benefit immediately on the death of the testator while at the same time protecting the assets for others i.e. the children.
A FLIT arises when a beneficiary, normally a surviving spouse, is given a life interest in the assets contained in the estate. The trustees have the power to pay income and often capital to the life tenant. While the life tenant is alive, the trust is treated as an interest in possession trust. However, on the death of the life tenant, the trust automatically turns into a discretionary trust and is therefore treated as a relevant property trust.
These types of trusts are therefore very flexible and ideal where the testator wants to provide for their surviving spouse during their lifetime whilst offering ongoing protection of trust assets for the other beneficiaries, up to a period of 125 years.
On the death of the testator, the residue of the estate is put into trust. The life tenant will be entitled to receive all income of the trust during their lifetime and will be treated as the main beneficiary. Trustees will still have discretion with regards to capital which can be given absolutely or loaned to the life tenant.
It is important to add that the flexibility of giving or lending capital does not extend to just the life tenant but the other beneficiaries also. For example, the trustees could exercise their discretion to use some of the trust funds to pay off a child’s mortgage if they request this.
As we have illustrated, given the flexibility with this type of trust, where the testator would like the trust funds to be distributed in a certain way or have concerns that they would like their trustees to be aware of, this should be set out in a letter of wishes.
The main disadvantage of a FLIT is the future IHT liability that this creates since assets in the FLIT would be treated as part of the life tenant’s estate for IHT purposes.
On the death of the life tenant, the trust will end and no longer qualify as an Immediate Post Death Interest trust. Instead, it will automatically become a discretionary trust and be treated as a relevant property trust, therefore anniversary and exit charges may apply.
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 NRB 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. It is important to add that these gifts will be considered as 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 and is taxed with reference to the relevant property regime which means anniversary and exit charges may apply.
Availability of RNRB
Where a main residence is left to a FLIT, the RNRB will not be available as on second death, the assets pass to a discretionary trust and not to direct descendants absolutely.
Everybody wants to protect their assets for the benefit of their loved ones. People are motivated to provide for their children throughout their lives and want what is best for them. Many people will draft a Will hoping to ensure that the assets that they have worked hard to acquire during their lifetime, are passed on to their children and chosen beneficiaries after their death.
However, a Will can only dispose of the assets that you own at the date of your death and if the value of these is eroded during your lifetime, there will be little if anything left for your beneficiaries to inherit.
Lifetime Living Trusts are specifically designed to protect your assets for you during your lifetime. They give you the peace of mind that your estate can be passed on securely and intact to your spouse, your children and their bloodline, or other named beneficiaries, after your death.
Once the Trust has been created, you can use it to ‘ring-fence’ your assets. Most people will protect their home and their savings, leaving capital in their bank or other savings accounts for ongoing living expenses. Income from savings protected within the Trust can be paid directly into your bank account to supplement income from earnings or pensions.
Just like a safety deposit box, assets can be added and removed from the Trust during your lifetime. If you have large expenses that cannot be met out of normal income, like a new car, holiday, or house repairs, the appropriate sum can be transferred to your bank account from the Trust.
You are named as the ‘Principal Beneficiary’ of the Trust and retain full control of the assets within the Trust while you are alive and have mental capacity. You are free to move home, or release equity from the Trust at any time.
As the Principal Beneficiary of the Trust, you have a guaranteed right of occupation in the property for the remainder of your life. The Trustees, usually your children, cannot evict you under any circumstances.
You can direct the Trustees to sell the property and to buy a new property of your choice. If the new property you are acquiring is more expensive, the Trustees can only be required to buy the new property if the additional capital required is paid into the Trust by you.
The Trust is equally applicable to married couples and to single people.
If you lose mental capacity, the law states that you are no longer allowed to manage your own affairs. Assets held within the Trust will then be managed by your Trustees on your behalf. Your Trustees can effectively ‘stand in your shoes’ to make decisions on your behalf but these must be for your benefit. They are able to add or remove assets or use the income from the Trust to help you and improve the quality of your life. Assets held outside the Trust will fall under the control of the courts. Creating a Lasting Power of Attorney will enable the people you choose to manage the assets that you own outside of the Trust.
After your death, the Trust continues to work to protect your assets for your beneficiaries. The Trust can continue to hold the assets safely within it, or pay them out to the specified beneficiaries. The Trust is extremely flexible after your death and has the potential to continue protecting your family for 125 years from the date it was created. That means that all of the benefits described in this document can not only protect you and your children but can also protect your grandchildren and great-grandchildren.