A flexible life interest trust (FLIT) is a type of trust that allows the surviving spouse to be the main beneficiary or life tenant who benefitsfrom having the life interest, whilst still alive. Only upon the surviving spouse’s death does it convert to a discretionary trust, which would be taxed as what is known as a relevant property trust.
It is a very popular type of trust that is embedded in many wills, because of several perceived advantages which include:
- Property being able to be passed to the surviving spouse whilst still being able to benefit from spousal exemption on death so that there is no inheritance tax on first death
- Protection against second marriages due to assets not belonging to the main beneficiary i.e. life tenant
- Protection against creditors as assets don’t belong to the life tenant
- Protection against the mismanagement of trust assets
- Children usually being the ultimate beneficiaries (remaindermen) are afforded similar third-party protection once the life tenant dies
However, a FLIT can create serious problems for families on second death with some of the immediate disadvantages being as follows:
- The entire estate enters the FLIT, and for inheritance tax purposes the entire estate is part of the survivor’s death estate and so liable to inheritance tax.
- The entire estate grows in the name of the life tenant, thereby losing the opportunity for at least £325,000 to grow within a discretionary trust on first death and to not become part of the survivor’s estate on second death.
- By allowing growth absolutely in the survivors’ estate, on their death, their estate is more likely to have breached the £2M threshold for the Residential Nil Brand Band (RNRB). Thereby, reducing or losing that relief.
- A FLIT relies on the transferable nil rate band (TNRB) still being available on second death. What if it isn’t? It has only been around since October 2007, and who knows what will happen in a post-Brexit economic climate.
Ultimately when it comes to exemptions such as the nil rate band (NRB), TNRB and the RNRB, if you don’t use it, be prepared to lose it. So, what’s the answer? It’d be short-sighted to simply say a discretionary trust, as discretionary trusts vary, and a trust is only as good as the trustees and in some instances, it may not be a trust at all. Ultimately, for families and individuals with complex estates which include multiple properties, business assets, offshore properties and blended families, the need for advice is paramount.
Mohammad Uz-Zaman is a private client trust and estate planning consultant who holds accreditations across regulated financial advice and estate planning. He holds graduate and post-graduate degrees and he is also an associate member of the Society of Trusts and Estate Practitioners (STEP). He works closely with financial advisers, general practice solicitors, accountants and investment managers from several major practices.