Flexible Life Interest Trusts (or Flit’s) are versatile trusts. They are slightly more complicated than an ordinary life interest or discretionary trust, but they combine the benefits of both. What follows is an overview of what the FLIT can be used for and what should be considered when advising on such a trust.
What is a Flexible Life Interest Trust?
A FLIT is essentially a combination of a life interest trust and a discretionary trust. The trust will name a life tenant and other discretionary beneficiaries. Whilst the life tenant, who is usually the testator’s surviving spouse or civil partner, is alive they are entitled to all income generated by the trust. The trust also includes a discretionary power that allows the trustees to advance capital to the life tenant.
When the life interest ends the trust will then continue as a discretionary trust for the discretionary beneficiaries. The life interest will normally end on the life tenant’s death, but this may be earlier as the life tenant may relinquish part or all their life interest or alternatively a FLIT may include a power for the trustees to revoke part or all the life interest.
How is a Flexible Life Interest Trust taxed?
The life tenant of the FLIT is treated for inheritance tax purposes as inheriting the trust assets. In the most common situation where the life tenant is the deceased’s spouse or civil partner, the spousal exemption will apply, and no inheritance tax is due on the deceased’s death. During the life tenant’s lifetime, whilst assets are held in the life interest there are no anniversary or exit charges payable, although this may change if part or all the life interest is revoked.
On the life tenant’s death, the trust assets are treated as part of the life tenant’s estate for inheritance tax purposes.
After the life interest ends, the trust is treated as relevant property. Anniversary and exit charges may apply from this point.
Due to the continuing discretionary trust on the life tenant’s death, RNRB cannot apply on the life tenant’s death if the deceased’s main residence passes to a FLIT, although the life tenant may still have their own assets owned personally that RNRB could apply to.
Why use a Flexible Life Interest Trust?
Asset protection is likely the main reason to place assets into a FLIT. Normally a FLIT would be used by a parent wishing to continue to benefit their spouse or civil partner but wishes to continue to protect assets for their children. The initial life interest allows the life tenant to benefit due to the entitlement to income and from the discretionary power to advance capital, but the assets held by the trust will be protected from third party claims such as bankruptcy or remarriage. When the life interest ends, the other discretionary beneficiaries do not inherit outright, and their inheritance is similarly protected from third parties if they are not in the best position to inherit at that time.
There are other reasons why a FLIT may be used alongside this, for example the discretionary trust on the life tenant’s death may avoid pushing a discretionary beneficiary’s own estate above the NRB and causing the beneficiary an IHT liability. The ability for the trustees to make gifts to the discretionary beneficiary’s whilst the life tenant is alive is also useful to make IHT planning on behalf of the life tenant using the trust assets as anything gifted to the other beneficiaries would be a potentially exempt transfer from the life tenant’s estate.