Interest in Possession Trusts
Balancing Financial Security With Asset Protection
An Interest in Possession (IIP) trust — often called a life interest trust — is one of the most useful tools in estate planning for families who need to look after two interests at once. It lets you give one beneficiary the right to income, or to live in a property, for their lifetime, while ensuring the underlying assets ultimately pass to the heirs you've chosen.
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It's a structure built for a very common and very human situation: wanting to provide for someone now, without giving away the capital that's meant for someone else later.
What is an Interest in Possession Trust?
The defining feature of an IIP trust is that it separates the right to income from the right to capital. Three roles make it work:
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The Life Tenant — the beneficiary with the "interest in possession." They're entitled either to all the income the trust generates (such as dividends or rent), or to live rent-free in a property the trust owns, for their lifetime.
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The Remaindermen — the ultimate beneficiaries, who inherit the trust's capital once the life tenant's interest ends, usually on their death.
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The Trustees — the legal owners of the assets, responsible for managing them and fairly balancing the needs of the life tenant and the remaindermen.
Why Use an Interest in Possession Trust?
This structure comes into its own in more complex family situations — particularly blended families and second marriages:
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Protecting a Surviving Spouse: You can ensure that a surviving husband or wife is financially secure for the rest of their life while preventing "sideways disinheritance" — the risk that your own children, perhaps from a previous relationship, are unintentionally excluded when assets pass entirely to a new spouse and then to their family.
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Preserving Capital: The underlying assets are protected from being depleted or mismanaged, remaining intact for the next generation.
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Providing Security for Those Who Need It: A steady, managed income can support a beneficiary who isn't in a position to handle significant capital directly.
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A common example is when a husband leaves his share of the family home in an IIP trust. His second wife can live there securely for the rest of her life — but on her death, the property passes to his children from his first marriage, exactly as he intended.
How Interest in Possession Trusts are Taxed
How Interest in Possession Trusts are Taxed?
The tax treatment of an IIP trust is genuinely intricate, and it depends heavily on when and how the trust was created. This is the area where professional advice matters most, but in broad terms:
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The Key Dividing Line is How the Trust Arose
IIP trusts created on death (through a will) and certain trusts created before 22 March 2006 are generally treated more favourably for inheritance tax — broadly, the trust assets are treated as belonging to the life tenant and form part of their estate when their interest ends. Most IIP trusts created during your lifetime after that date, by contrast, are usually taxed under the "relevant property regime", which has its own entry charges, ten-yearly periodic charges and exit charges.
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Inheritance Tax
For a "qualifying" IIP (such as one created by will), the value of the trust is normally added to the life tenant's estate on their death, which can mean the spouse exemption applies if the life tenant is a surviving spouse, deferring inheritance tax until the second death.
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Income Tax
The income belongs to the life tenant, who is taxed on it at their own rates, with credit for tax already paid by the trustees.
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Capital Gains Tax
Trustees may face CGT on disposals of trust assets, and special rules may apply when the life tenant's interest comes to an end.
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Because the rules turn on fine distinctions — and because tax legislation changes — the right structure should always be confirmed with professional advice before you act. Tax treatment depends on individual circumstances and current law.
When Disputes Arise
Like any trust, an IIP can become the subject of disagreement, and understanding where the friction points lie helps you guard against them. The most common include:
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Tax Status Disputes: Questions over whether a trust is a qualifying IIP or falls within the relevant property regime, which can significantly change the tax outcome.
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Mistake and Rectification: A trust deed doesn't reflect what the settlor actually intended, sometimes requiring a court to correct it.
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Life Tenant vs Remaindermen Conflicts: The structural tension at the heart of every IIP, where the income beneficiary wants higher returns now and the capital beneficiaries want growth preserved for later.
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Most of these problems trace back to the same root cause: a trust deed that wasn't drafted with enough care or foresight. Clear, professional drafting – and well-chosen, impartial trustees – is the most effective protection against them.
Secure Your Family's Future
An interest in possession trust is a precise instrument, and it relies on a carefully drafted trust deed to make your intentions both legally binding and tax-efficient. We'd be glad to help you get it right.