Loan Trust / Inheritance Tax Planning

 

Background

The inheritance tax (IHT) ‘gift with reservation’ rules have made it difficult for clients to achieve an inheritance tax saving whilst retaining an income or future benefit from their assets. However, there are accepted measures that can be used to solve this difficulty.

Suitability

A loan trust may be suitable for:

•    Individuals who have total assets in excess of twice the nil rate band of inheritance tax, and who are already using the nil rate band in their wills on the first death,

•    Individuals who wish to reduce the future growth of their estate so as not to add to the IHT liability, but who do not wish to gift assets,

•  Individuals who have surplus capital which is not currently needed to support their life-style, but to which access may be needed in the future.

Mechanics

Under the Loan Trust the individual is able to make an interest free loan repayable on demand to the Trustees. The Trustees then place the amount of the loan into a single premium life assurance bond which is written in trust for the chosen beneficiaries. As the bond grows in value (assuming that it does) the growth will fall immediately outside the settlor’s estate for the benefit of the chosen beneficiaries. There is no requirement to survive for any period of time.

As the interest free loan is not a gift for inheritance tax purposes there is no potential inheritance tax charge on setting up the trust. However, it needs to be remembered that the outstanding value of the loan will remain inside the estate.

Under the trust that the settlor (who would typically also be a trustee) can make withdrawals from the bond in order to repay the loan made over a period of time. These regular withdrawals could be used to provide an ‘income’ each year (return of original capital).

Recalling the Loan

An clear advantage of this planning is that if the capital is required at any point, the settlor can ask for the loan to be repaid.

Tax

On death any outstanding loan will form part of the settlor’s estate for IHT purposes. For example;

•   Original loan = £100,000.

•   5% ‘repayments’ taken = £60,000 has been ‘repaid’.

•   Value of Investment £90,000.

•   In this example £100,000 - £60,000 = £40,000 remains in estate – therefore the growth on the investment (£90,000 - £40,000) is outside of the estate.

 

Additional Advantages

If the bond under the loan trust arrangement had been written on the settlor’s sole life, then the bond would automatically encash. The executors would then repay any outstanding loan to the settlor’s estate (using the example above this would be £30,000), whilst the balance would be payable to the beneficiaries under the trust.

However if the bond under the loan trust arrangement had been written on lives assured other than the settlor, it could then continue after the settlor’s death.

For further information and discussion about Inheritance Tax planning please contact one of the team.