Interest in Possession trusts has played an enduring role in estate planning across the UK, particularly where there is a desire to balance the needs of one beneficiary with the future interests of others. Although legislative changes over the past two decades have significantly altered their tax treatment, these trusts remain a valuable tool for many families and individuals navigating complex financial and familial arrangements.
At its core, an Interest in Possession trust provides a named beneficiary - the ‘Life Tenant' in England and Wales or the ‘Life Renter' in Scotland - with an immediate and ongoing right to income generated from trust assets. While they may enjoy the benefits of income or occupation (such as living rent-free in a trust-owned property), they do not own or control the capital assets themselves. Instead, the capital is preserved for one or more other beneficiaries, known as the ‘Remaindermen', who will inherit the trust property after the Life Tenant's interest ends.
This arrangement strikes a balance between current and future interests, which is particularly valuable in second marriages, multi-generational households, and estates where wealth preservation and flexibility are priorities. Unlike Discretionary Trusts, where no individual has a fixed right to income or capital, the Life Tenant in an Interest in Possession trust is guaranteed the right to benefit from the trust during their lifetime or for the duration of the interest, unless specific conditions, such as remarriage or cohabitation, terminate their entitlement.
Interest in Possession trusts are most frequently seen in wills, especially where a person seeks to provide for their surviving spouse or civil partner while ultimately ensuring their assets pass to children from a previous relationship. For instance, a testator may stipulate in their will that their second spouse may live in the family home for life, with the property passing to children from their first marriage upon the second spouse's death. This prevents the forced sale of the home while safeguarding the children's eventual inheritance.
Such arrangements are especially relevant in modern blended family contexts, where protecting both current partners and children from earlier relationships is essential. They also offer peace of mind in ensuring that dependent family members, such as elderly relatives or financially vulnerable beneficiaries, receive support during their lifetimes.
Another common application is in the provision of rent-free accommodation. The Life Tenant may not receive a cash income from the trust, but instead benefits by living in a trust-owned property, with the trustees covering maintenance and other relevant expenses.
Trustees must carefully manage the trust's investments to satisfy the interests of both the Life Tenant and the Remaindermen. For example, if the trust includes income-generating shares or rental property, the Life Tenant benefits from the returns, while the capital growth benefits the Remaindermen. This dual responsibility requires a balanced investment strategy unless the trust deed explicitly gives preference to one party over the other.
Establishing an Interest in Possession trust requires drafting a trust deed that clearly outlines the terms of the arrangement, identifies the Life Tenant and the Remaindermen, and specifies the trustees' powers and duties. Trustees become the legal owners of the assets and are responsible for administering them in line with the trust's objectives.
Following the trust's creation, registration with HMRC's Trust Registration Service is necessary if the trust generates income not paid directly to the Life Tenant or if there are chargeable capital gains. Ongoing compliance involves submitting tax returns and maintaining accurate records, particularly if the trust becomes subject to periodic or exit charges.
Crucially, trustees cannot accumulate income in an Interest in Possession trust. Any income must either be paid to the Life Tenant or mandatorily applied for their benefit. If the Life Tenant is entitled to income but does not actually receive it, they are nonetheless treated for tax purposes as if they had.
Prior to 22 March 2006, the tax advantages of Interest in Possession trusts made them an attractive choice for lifetime wealth planning. Transfers into such trusts were classified as Potentially Exempt Transfers (PETs), meaning they were exempt from Inheritance Tax (IHT) if the settlor survived for seven years following the transfer. Additionally, the trusts were not subject to periodic or exit charges, placing them outside the scope of the 'relevant property' regime.
However, the Finance Act 2006 introduced significant changes. For trusts created on or after 22 March 2006, lifetime transfers into Interest in Possession trusts are no longer treated as PETs. Instead, they are immediately chargeable to IHT, unless the value transferred falls within the settlor's available nil-rate band, currently £325,000 (as at 2023/24). Trusts exceeding this threshold face a 20% IHT charge on the amount above it.
Moreover, new Interest in Possession trusts are generally subject to the ten-yearly periodic charge (up to 6%) and exit charges on the distribution of capital. These charges are calculated based on the value of the trust assets and the timing of distributions.
Despite these changes, certain Interest in Possession trusts created by will - known as Immediate Post-Death Interests - retain favourable treatment, as do some pre-existing arrangements under the transitional rules introduced alongside the 2006 reforms.
In response to the 2006 reforms, the concept of the Transitional Serial Interest (TSI) was introduced. TSIs allow certain trusts established before 22 March 2006 to retain their pre-reform tax treatment, even when the Life Tenant changes.
There are three key scenarios where TSIs apply:
1. Transitional Period to 5 October 2008 (s49C IHTA 1984)
Between 22 March 2006 and 5 October 2008, a Life Tenant could assign their interest to a successor without triggering the relevant property regime. For example, if a father passed his life interest to his daughter within this window, the trust retained its original treatment, and the daughter's interest was covered by the transitional rules.
2. Surviving Spouse or Civil Partner Trusts (s49D IHTA 1984)
When a Life Tenant dies and their surviving spouse or civil partner becomes the new beneficiary, the successor's interest qualifies as a TSI. As such, the trust is not brought within the relevant property regime, and IHT is assessed on the spouse's estate at death. The spousal exemption applies to the initial transfer of the life interest.
3. Life Insurance Trusts (s49E IHTA 1984)
For life insurance policies settled into trust before 22 March 2006, a TSI arises if the original Life Tenant dies and a new beneficiary becomes entitled to the interest. If the change occurs on death and not during the lifetime of the prior tenant, the new interest will be treated under the pre-2006 rules, preserving valuable tax advantages.
The practical implications of TSIs can be illustrated through typical family scenarios.
Take, for instance, a man named Eddie who held a life interest in a trust from 2007. On 1 October 2008, just before the end of the transitional window, he assigned his interest to his daughter Janet. Under the transitional provisions, Janet is treated as the new Life Tenant under the pre-2006 rules.
Eddie made a PET, and if he survived seven years, no IHT would be due.
In another scenario, consider Andrew, who had a life interest from 2002. Upon his death in 2010, his wife, Susan, became the new Life Tenant.
Her entitlement qualifies as a TSI under section 49D. The trust remains within Susan's estate but avoids the relevant property regime, maintaining its favourable treatment.
A final example involves a life insurance trust created in 2005. The original Life Tenant, Michelle, died in 2009. Her husband Victor inherited the life interest, and upon his later death, the capital passed to her children. Here, the pre-2006 treatment continues throughout the trust's life, avoiding periodic and exit charges.
Interest in Possession trusts remains a viable option in estate planning, especially when the settlor wishes to guarantee a steady income or residence to one person while preserving the underlying capital for future beneficiaries. Though the 2006 reforms curtailed many of their historic tax benefits, careful structuring and awareness of transitional rules can still yield significant advantages.
They are particularly useful in second marriages and where the objective is to provide security to one person without sacrificing inheritance rights for others. Trusts established before March 2006, or those qualifying for Transitional Serial Interest treatment, continue to offer valuable tax efficiencies.
As with any trust arrangement, professional legal and financial advice is essential. Trustees must understand their responsibilities, the interplay between income rights and capital preservation, and the implications of tax legislation. When used appropriately, an Interest in Possession trust can offer clarity, control, and continuity - key ingredients in any robust estate plan.
At Premier Solicitors, our experienced trust and estate planning team can guide you through the complexities of setting up and managing an Interest in Possession trust. Whether you're looking to protect loved ones, structure your estate tax-efficiently, or navigate the transitional rules post-2006, we're here to offer clear, practical advice tailored to your circumstances.
For more information, please call us on 01234 358 080 or visit our contact page to send an enquiry form.
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