How a loan trust may help IHT planning

The following article provides information about inheritance tax planning for UK domiciled individuals where access to capital is required.

Case study

Peter Smith (aged 54) has always lived and worked in the UK. He has been happily married for 30 years. They have two children, Sally and Steven. Sally is pregnant with his first grandchild. His income is £50,000 and he recently received an inheritance of £750,000 from his late mother.

He wants to retain the benefit from this capital to meet future needs and also ensure his family don’t pay more inheritance tax (IHT) than they need to.

Peter could set up a loan trust by lending the capital to the trustees of the loan trust. If he chooses a discretionary version of the loan trust, this will allow not only his current family but his future grandchild to benefit from the trust fund. Alternatively, he could set up an absolute version of the loan trust if he requires certainty as to who will benefit from the trust.

The loan is made interest free and is repayable to Peter on demand. Any growth on the loan once the trust is created forms the trust fund and is therefore out of his estate for IHT immediately. This effectively freezes the value of Peter’s estate for IHT.

The amount of the outstanding loan does form part of Peter’s estate for IHT purposes, however this amount can be reduced by Peter taking regular or one off loan repayments (provided he spends this money).

If the trustees of the loan trust (of which he can be one) choose to invest in an offshore bond, then loan repayments of 5% of the amount invested in the bond can be taken each year without triggering a chargeable event for income tax for up to 20 years. This allowance is cumulative so if 5% if not taken in year one, 10% can be taken in year two, and so on.

How an offshore bond subject to a loan trust may help

  • Ability to access the capital lent to the trustees at any time.
  • Any growth will be immediately outside the settlor's estate for IHT.
  • Outstanding loan is within the settlor's estate for IHT.
  • Loan repayments reduce the value of outstanding loan and therefore IHT payable if spent.
  • If loan repayments paid by a partial encashment of a policy are limited to 5% then no chargeable events.
  • Loan repayments by full surrender of individual policies is possible for loan repayments above 5% which may reduce or avoid a chargeable event.
  • Investment grows tax free (except for withholding taxes).
  • Does not trigger an income tax charge under Pre Owned Assets Tax.
  • The loan may be gifted during lifetime or on death to either the beneficiaries or another party within the client’s will.
  • Flexibility over who benefits for discretionary version.
  • Certainty over who benefits with a bare version.

Additional points to consider

  • Unable to access the growth on capital once lent.
  • Taking back the whole amount in the early years may incur encashment charges depending on charging structure selected for bond.
  • Loan repayments above the 5% tax deferred allowance will trigger a chargeable event payable by the client.
  • If loan repayments are not spent, they remain within client’s estate for IHT.
  • Outstanding loan is within the settlor's estate for IHT.
  • Where the trustees are not Old Mutual International Trust Company, the loan can be limited or unlimited liability. Where the trust is unlimited liability, if the value of the bond falls below the level of the outstanding loan at the time of repayment, the trustees are personally liable to cover the shortfall.

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth's interpretation of the relevant law and is correct at the date shown on the title page. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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