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Interest in Possession Trusts

Interest in Possession Trusts grant a beneficiary or class of beneficiaries a right to receive income from the trust property. This “interest in possession” can be written into the trust deed for a fixed number of years, or for the rest of the beneficiary’s life or indefinitely.

The beneficiary entitled to the income of the trust is often referred to as a ‘life tenant’ or as ‘having a life interest’. A beneficiary entitled to the trust capital is known as the ‘remainderman’ or the ‘capital beneficiary’. The life tenant receiving income usually does not have any rights over the capital of the Interest in Possession Trust since the capital will normally pass to “remainderman” at some point in the future. Depending on the wording of the trust deed, the trustees may exercise their powers of discretion to distribute capital to a life tenant.

A transfer of property into the Interest in Possession trust is deemed to be a “Chargeable Lifetime Transfer” (CLT) for Inheritance Tax (IHT) purposes. This means that if the amount gifted into the Interest in Possession trust exceeds the donor’s available Nil Rate Band, IHT will be payable immediately at 20% on the excess.

Interest in Possession Trusts are subject to ongoing IHT exit charges when capital is distributed to a beneficiary and is also subject to 10 year periodic charges. Effectively, this periodic tax charge is no more than 6% of the value of the trust assets in excess of the Nil Rate Band. For these purposes the Nil Rate Band available to the trust is the current Nil Rate Band (i.e. at the time the charge arises) less any CLTs made in the seven years prior to establishing the trust and previous Potentially Exempt Transfers, such as gifts into absolute trust, are ignored for these purposes. This is different to inheriting an Interest in Possession trust from someone who has died where there is no IHT periodic charge at the 10-year anniversary. Instead, 40% tax will be due the inheritor dies.

An Interest in Possession Trust provides flexibility and control because the trustees can decide who they wish to benefit and when. Notwithstanding this flexibility and control, any income generated from the trust assets must be paid to the beneficiary(ies) having the interest in possession, less any trustees’ expenses. Since an investment bond is a non income producing asset, Trustees can decide when to generate an income using the 5% cumulative tax deferred allowance. If the trust asset was an income generating asset, such as a high yielding unit trust, the income would need to be distributed as and when it arises.

Trustees are responsible for declaring and paying Income Tax on income received by the trust. Again this favours the use of an investment bond as the investment vehicle for the trust property since Trustees only need to submit tax returns when a Chargeable Event occurs, so avoiding the administrative burden of completing a yearly Trust and Estate Tax Return.