Loan trusts have been a part of estate planning for many years and this follows on from my previous blog about Discounted Gift Trusts. However, are they useful? Should they be used first, second or as last resort?
I think it is worth explaining how loan trusts work as, given an example used by a large international advice firm, it is clear that the use of loan trusts is not understood that well by some. The fact is that they are really quite simple structures and easy to explain.
Loan Trusts – Gifts and IHT
These are used by those that do not want to make outright gifts and, the good news, there are no initial IHT charges that would apply. Therefore, we need to be clear, loan trusts are not gifts into trust.
Loan Trust- How do they work?
We have already established that trusts are straightforward and loan trusts are no different.
An individual sets up a trust and makes an interest-free loan to the trust that is repayable on demand. The trustees invest this loan into an insurance bond. The loan value is set in stone and remains in the settlor’s (the person lending the money) estate for IHT. Importantly, the growth that the investments make within the bond are outside of the estate and this is where the IHT savings arise as the settlor is not the beneficiary.
If the settlor requires part repayment of the loan the trustees can make partial surrenders from the bond but tax advice on how this is access would be essential as chargeable events (usually if more than 5% pa is repaid) are taxed on the settlor.
It is important to understand that loan trusts do not trigger the Gift With Reservation rules as the settlor is a creditor and there is no gift to which these rules can be applied to in any event!
Loan Trusts – How effective are they for IHT planning
There is no immediate IHT saving and so the settlor needs to live a long time to get the benefit of growth outside of his/her estate. No growth means no benefit. Minus growth (losses) are even worse!
There is no point having the loan repaid if the money is then saved, if it is not spent then it will remain in the estate and be taxed on death.
Bear in mind, on death, the remaining loan balance is an asset of the deceased’s estate. Also, if the fund has not been invested well, then the fund may be lower than the outstanding loan. If this happens, one assumes the trustees liability has be restricted under the loan agreement. If so, is the shortfall a ‘transfer of value’ when it is written off- thus making the estate, and the IHT bill, larger than it would have been?
A test case on this would clear this up, but I am not aware of such a case to date.
Loan Trusts are not hugely useful as they carry the risk without huge benefits. They are useful for people with very large estates who can invest for the long term and who do not wish to give up complete access. However, if the value of the investment is below the original transfer, then the person is left nursing a loss, with the original IHT bill still valid. We would consider other IHT planning tools before using a loan trust but we would not dis-regard them either!
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The views expressed in this article are not to be construed as personal advice. You should contact a qualified and ideally regulated adviser in order to obtain up to date personal advice with regard to your own personal circumstances. If you do not then you are acting under your own authority and deemed “execution only”. The author does not except any liability for people acting without personalised advice, who base a decision on views expressed in this generic article. Where this article is dated then it is based on legislation as of the date. Legislation changes but articles are rarely updated, although sometimes a new article is written; so, please check for later articles or changes in legislation on official government websites, as this article should not be relied on in isolation.
This article was published on 10th November 2017
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