Definition
An interest-in-possession trust is a type of fixed-interest trust wherein the designated beneficiaries, known as life tenants, have an entitlement to the trust’s income for a specified term or until their demise. This ensures that the income generated by the trust’s assets is reserved for the life tenants. Post this period, the capital held within the trust is then transferred to another beneficiary known as the remainderman.
Formerly, any lifetime transfer into an interest-in-possession trust was considered a potentially exempt transfer for inheritance tax purposes. However, since March 2006, such transfers are generally no longer allowed unless the trust is designed to benefit a disabled person. This type of trust contrasts with a discretionary trust, where trustees have more leeway in distributing income and capital.
Examples
-
Example 1: Family Trust
- A grandmother sets up an interest-in-possession trust to provide her son (the life tenant) with income during his lifetime. Upon his death, the capital is to be split between her grandchildren (the remaindermen).
-
Example 2: Estate Planning
- An individual creates an interest-in-possession trust to provide his spouse with a source of income after his death. Once the spouse passes away, the remaining assets in the trust will then be transferred to their children.
Frequently Asked Questions (FAQs)
Q1: What is the key difference between an interest-in-possession trust and a discretionary trust?
- A1: An interest-in-possession trust guarantees income to particular beneficiaries (life tenants) for a set period or until their death, whereas a discretionary trust allows trustees to decide how and when income or capital from the trust is distributed among beneficiaries.
Q2: Can new interest-in-possession trusts be created for tax purposes now?
- A2: New interest-in-possession trusts cannot be created for inheritance tax advantages post-March 2006, except for trusts designed for disabled individuals.
Q3: Who are the main parties involved in an interest-in-possession trust?
- A3: The main parties involved include the settlor (creator of the trust), life tenants (beneficiaries entitled to income), trustees (administrators of the trust), and remaindermen (beneficiaries who receive the capital after life tenants).
Q4: What happens if the life tenant of an interest-in-possession trust dies?
- A4: Upon the death of the life tenant, the capital in the trust is automatically transferred to the remaindermen designated in the trust deed.
Q5: Are there any specific tax implications for income received from an interest-in-possession trust?
- A5: Yes, typically, the income received by life tenants is subject to income tax as usual. The trust itself may face certain tax obligations, such as inheritance tax, depending on how it’s structured.
Related Terms
- Life Tenant: An individual entitled to the income generated by the trust for their lifetime or a set period.
- Remainderman: The beneficiary who receives the capital of the trust after the life tenant’s interest ends.
- Discretionary Trust: A trust where trustees have the discretion to decide how income or capital is distributed among the beneficiaries.
- Potentially Exempt Transfer (PET): A transfer that could be exempt from inheritance tax if the donor survives for seven years after the transfer.
- Inheritance Tax: A tax levied on the estate of the deceased upon transfer to beneficiaries.
Online References
Suggested Books for Further Studies
- “Trusts and Equity” by Richard Edwards and Nigel Stockwell
- “Law of Trusts (Core Texts Series)” by Alastair Hudson
- “Understanding Trusts and Estates” by Roger W. Andersen and Ira Mark Bloom
Accounting Basics: “Interest-in-Possession Trust” Fundamentals Quiz
### For how long can a life tenant receive income from an interest-in-possession trust?
- [x] For a fixed period or until their death
- [ ] Indefinitely, without conditions
- [ ] Until the trustee decides to stop it
- [ ] None of the above
> **Explanation:** A life tenant is entitled to receive income from an interest-in-possession trust for either a specified fixed period or until their death.
### Who receives the capital of the trust after the life tenant's income entitlement ends?
- [x] The remainderman
- [ ] The trustee
- [ ] The settlor
- [ ] None of the above
> **Explanation:** After the life tenant's entitlement to income ends, the capital of the trust is passed on to the remainderman, as specified in the trust deed.
### What happened to the creation of new interest-in-possession trusts for tax benefits after March 2006?
- [ ] It became more favorable for tax benefits.
- [x] It is generally no longer allowed unless for disabled individuals.
- [ ] They were not affected by this change.
- [ ] They were outlawed entirely.
> **Explanation:** Post-March 2006, new interest-in-possession trusts can no longer be created for inheritance tax benefits, except if they are for the benefit of disabled persons.
### Which trust allows trustees the discretion to decide income distribution among beneficiaries?
- [ ] Interest-in-possession trust
- [x] Discretionary trust
- [ ] Revocable trust
- [ ] Irrevocable trust
> **Explanation:** In a discretionary trust, trustees have the flexibility to decide how income and capital are distributed among the beneficiaries.
### What happens if the remainderman of a trust passes away before the life tenant?
- [ ] The life tenant inherits the capital.
- [ ] The trust is dissolved immediately.
- [x] A new remainderman may be specified, or terms may be outlined in the trust deed.
- [ ] The trustee owns the trust in perpetuity.
> **Explanation:** If the remainderman passes away before the life tenant, the terms of the trust deed generally specify an alternative remainderman, or the settlor might have outlined provisions for such an occurrence.
### What kind of tax implication is there for the life tenant’s income from the trust?
- [ ] It is sheltered from all taxes.
- [ ] It is only taxed upon trust dissolution.
- [x] The income is subject to regular income tax.
- [ ] None of the above
> **Explanation:** The income received by life tenants from an interest-in-possession trust is subject to normal income tax regulations.
### Who usually appoints the taker during the initiation of an interest-in-possession trust?
- [ ] The current government officials
- [ ] The benefactor companies
- [x] The settlor creating the trust
- [ ] The legal counsel
> **Explanation:** The settlor is the individual who creates the trust and appoints the life tenants and remainderman during the initiation of an interest-in-possession trust.
### What type of trust was used as a potential exempt transfer for inheritance tax before March 2006?
- [x] Interest-in-possession trust
- [ ] Discretionary trust
- [ ] Charitable trust
- [ ] Spendthrift trust
> **Explanation:** Before the change in tax laws in March 2006, lifetime transfers into an interest-in-possession trust qualified as potentially exempt transfers for inheritance tax purposes.
### Which primary benefit recipient directly gains from the trust's income during its operational lifetime?
- [ ] Remainderman
- [ ] Settlor
- [x] Life tenant
- [ ] Trustee
> **Explanation:** During the operational lifetime of the trust, the primary beneficiary of the income generated is the life tenant.
### What is the common purpose of an interest-in-possession trust in estate planning?
- [ ] To evade all sorts of taxes
- [x] To provide a steady income to the life tenants and eventually pass on capital to the remainderman
- [ ] To ensure beneficiaries can access funds whenever they please
- [ ] To avoid legal ramifications
> **Explanation:** In estate planning, interest-in-possession trusts are commonly used to provide life tenants with a steady income and ensure that the capital is passed on to the remainderman, aligning with the specific wishes of the settlor.
Thank you for delving into the complexities of interest-in-possession trusts and testing your understanding through our sample quiz questions. Keep enhancing your financial and legal knowledge!
