Life interest trust of the family home on death
Where a property is owned jointly, it is worth considering whether you should create a life interest trust on the death of the first joint owner. This would typically be set out in your will. This note explains how that can be done and the advantages and disadvantages.
Although we have referred to the spouse below, these provisions apply equally to unmarried couples and those in a Civil Partnership. Although the term property can apply to any asset, for the purposes of this note, it’s meant to refer to the house or flat you live in.
What is a life interest trust of property?
Put simply, the beneficiary has the use of the property during their lifetime, but on their death, it passes to a third party; e.g. A house is left to a spouse to live in during their lifetime, but on their death, the house passes to children.
In the above case, the spouse can’t leave the property in their will as their interest ends on their death.
In order to create such a trust of your family home it will be necessary to hold the property as tenants in common. This means both parties own 50% each. You then give your spouse a life interest in your half share in your will. When one of you dies the survivor inherits a life interest in the others 50%. They can continue to live in the whole house for the rest of their life but only own half of it. If they wish they can sell the house and buy another one so long as they preserve half the underlying capital in the new property.
Advantages of creating a life interest
Creating a life interest means you control the ultimate destination of your property. The surviving spouse has a home to live in but the first spouse to die can be sure that at least half of the house will ultimately pass to the children, or other beneficiaries. Their half of the property cannot be used to pay care home fees. If the survivor decided to go on a spending spree, or remarried or went into care then another party could spend or inherit only their half of the house etc.
This can be a useful way of avoiding all of your assets going in care home fees and addressing the conflicting issues which arise on a second marriage. A new spouse can continue to live in the house, but on the death of the original surviving spouse the half share in the property passes to children or other beneficiaries.
Creating such a trust doesn’t save any Inheritance tax. As we explain below. Its two main advantages are:
Disadvantages of creating a life interest
On the death of the first spouse, the survivor doesn’t inherit the deceased’s share of the house outright; they only have the right to live in it. While this may not be a problem in later life it can be if one of the joint owners dies at a young age. For many couples their house can be the main asset they own. Only having access to half its capital value can be a significant issue.
A life interest gives a right of occupation and a right to any income, if for example the property was rented out. The surviving spouse can normally move home and use the deceased spouse’s share to buy another property provided there isn’t a loss in value. What the survivor can’t do is spend the deceased spouse’s share of capital.
While many people would prefer not to paying nursing home fees, the fact you don’t have access to all of your capital may affect the kind of care home you can afford to live.
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Property can be owned in one of two ways:
1. Joint tenants
The property belongs to you jointly and on the death of one spouse it automatically passes to the survivor. You cannot leave jointly owned property in your will. To create a life interest under your will you need to hold the property as tenants in common.
2. Tenants in common
You both have a distinct share in the property which you can leave in your will.
Severance of a joint tenancy
You can sever a joint tenancy and hold the property as tenants in common by service of a notice of severance and registering it at the Land Registry.
Inheritance tax (IHT)
This is generally only an issue if your combined estate is worth more than £650,000. In calculating this sum you must include any property you have given away in the previous seven years over and above the sum of £3,000 per annum. You must also include property you have given away but continue to use i.e. a holiday home.
You may also qualify for the Residential Nil Rate Band, which by 2021 can increase your join IHT allowance to £1,000,000. However not all people will qualify for this additional allowance and therefore for the purposes of this note we have disregarded it. We will be happy to discuss with you whether or not you qualify for it.
If you have not given any assets away and your estate is less than £650,000 you can ignore this section.
Where Inheritance tax is payable, the surviving spouse is treated as owning the whole property for Inheritance tax purposes. This can be more of an issue for un-married couples who don’t have the benefit of the spouse exemption and transferrable nil rate band. If the spouse or un-married partner had inherited the whole property then similar Inheritance tax principles would have applied and therefore creating a life interest is generally tax neutral. If Inheritance tax is payable, its born pro rata between the trust and the second spouse’s estate.
A and B are married. On A’s death B inherits a life interest in A’s half of the house. On B’s death the house is worth £600,000 and B has savings of £300,000. B is treated for Inheritance tax purposes as having an estate of £900,000.
B’s actual estate is half the house £300,000 + the £300,000 = £600,000
The trust which holds the life interest has half the house £300,000.
So 2/3 of any tax due would be payable by B’s estate and the trust would pay 1/3. This tax is payable from the half share of the house held in trust
This is general advice and is meant for information purposes only. It should not be relied upon and specific advice should be obtained on any legal problem
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