How Loan Trusts can help with Inheritance Tax Planning

Anne-Maria Crisafi, Senior Paraplanner

Inheritance Tax Planning is a fundamental part of wealth management, with sophisticated planning we can ensure opportunities are not missed.

There are a number of ways in which you can look to reduce the Inheritance Tax (IHT) liability on your estate. These typically involve giving away assets either directly to an individual or via a Trust, or investing into investment schemes which benefit from IHT reliefs (such as business relief qualifying investments).

The downside of these options is that you either lose control or the right to benefit from the asset or take significant investment risk with the investment. Furthermore, giving assets away while continuing to ‘benefit’ from them is ineffective for planning due to what is referred to as ‘the gift with reservation’ rules.

What is a Loan Trust?

A Loan Trust enables you to undertake IHT planning without the need to give capital away or to take higher levels of investment risk. A Loan Trust is not caught by the gift with reservation rules and is not a transfer of value for IHT purposes.

With a Loan Trust, money is loaned rather than gifted into Trust, which is then invested (typically within an investment bond), for the benefit of the Trust beneficiaries.

The Settlor of the Trust, or the person who makes the loan into the Trust, retains control and ownership of the loan at all times but is not allowed to access the growth produced. On the other hand, the beneficiaries of the Trust are able to access the growth produced by investment of the loan but not the loan itself. This is demonstrated as follows.

Types of Loan Trust

The Loan Trust can either be set up as an Absolute Trust (the beneficiaries have an absolute right to the growth on the fund and can demand access once they reach adulthood) or a Discretionary Trust (the Trustees decide who will benefit from the Trust fund and when).

Loan repayment

The Settlor of the Trust can request that some or all of the loan is repaid at any time and in any manner. However, care needs to be taken if the Loan Trust is held within an investment bond as there may be tax consequences associated with taking a withdrawal which is in excess of the available 5% tax deferred withdrawal allowance.

You are only able to access the amount loaned into the Trust and no withdrawals are permitted once this loan has been fully repaid. It is important to note that the loan remains inside your estate at all times, although loan repayments which are used to supplement income may also help reduce your IHT liability.

If you decide that you no longer need access to the amount loaned into Trust, you can choose to waive the right of repayment (partially or in full) or pass the right to the loan to another person. Any loan given away will be outside your estate after seven years, unless covered by an exemption.

Partial loan repayments should be spent for the structure to be most effective for IHT planning, but they are not income, so can’t be used to make gifts out of excess income.

In addition, the loan is interest free, repayable on demand, so partial loan repayments can be switched off in the earlier years while the underlying funds grow. When the loan has been repaid in full, the Settlor can have no further benefit from the Trust fund in order to avoid ‘gift with reservation’ issues.

IHT advantages

Any growth on the loan is immediately outside your estate for IHT purposes, which can help ‘cap’ the value of assets held inside your estate (avoid making the IHT liability worse), although a number of years is required in order to fully benefit from this.

If you would like to discuss how Loan Trusts could benefit you, then please speak with your financial adviser or contact one of our Financial Planning Consultants who will be delighted to discuss this further with you.

Please note the information contained is correct as at the date of this article.

Disclaimers

Crowe Financial Planning UK Limited is authorised and regulated by the Financial Conduct Authority (‘FCA’) to provide independent financial advice.

The information set out on this page is for information purposes only and is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. It does not constitute advice to undertake a particular transaction. Appropriate professional advice should be taken on specific issues before any course of action is pursued. Any advice provided by a Crowe Consultant will follow only after consideration of all aspects of our internal advice guidance.

Past performance is not a guide to future performance, nor a reliable indicator of future results or performance. The value of investments, and the income or capital entitlement which may derive from them, if any, may go down as well as up and is not guaranteed; therefore, investors may not get back the amount originally invested.

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