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 are 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.
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), with the growth being held 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.
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).
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 invested in an investment bond as there may be tax consequences associated with taking a withdrawal which is in excess of the available 5% withdrawal allowances or if whole segments are encashed.
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 outstanding 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 to 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. If 5% withdrawals are taken each year from the bond by the Trustees and used to fund partial repayment of the loan, by the end of year 20 the loan has been repaid in full and the Settlor can have no further benefit from the Trust fund to avoid ‘gift with reservation’ issues.
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 advisor 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.
The information set out in our publications is for information purposes only and 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 aspect of our internal advice guidance.
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