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REVIEW SUMMARY

Loan Trust

A loan trust enables a settlor to make a gift of growth on a loan, while retaining unrestricted access to the loan capital.

The growth on the investment is outside the settlor’s estate for IHT purposes.

The trust has received a loan from the settlor, not a gift, so there is no immediate IHT liability in most circumstances.

Overview
FAQ
Customer Reviews
Expert Verdict

A loan trust involves an individual establishing a trust. But rather than making a gift, the settlor lends money to the trust. The trustees then invest this money, typically into an investment bond, for the benefit of the trust beneficiaries.

The settlor can demand repayment of the outstanding loan at any time - this can either be in full or in part. If regular loan repayments are needed, the trustees can repay the loan by using the 5% tax deferred withdrawal facility from the bond.

The settlor cannot benefit from the trust fund - any fund growth must be used for the benefit of the trust beneficiaries.

Key features of a loan trust:

  • The amount of the outstanding loan remains within the settlor's estate for IHT.
  • Any growth, over and above the outstanding loan, is immediately outside the settlor’s estate.
  • The loan is interest free and repayable on demand.
  • The 5% tax deferred allowance on bonds can be used to make loan repayments without an immediate tax charge.
  • If access to the loan is no longer required it can be waived or gifted.
  • Waiving or gifting the right to the loan in the settlor’s will can avoid the need to call in the loan and a possible chargeable gain.

Steps involved in creating a loan trust:

Typically the creation of a loan trust requires the following steps.

  1. The trust is created.
  2. Loan agreement completed between the settlor and trustees and a loan of cash is made to the trustees.
  3. Trustees invest the cash from the loan into an investment bond.

These are typically all packaged together and included in the provider’s documentation.

Trust options:

The first step is to create the trust. The trust has to be in place before the loan agreement can be drawn up. A loan trust will typically offer three trust options:

  • Absolute trust
  • Flexible (interest in possession) trust
  • Discretionary trust

Under the absolute trust, the beneficiaries are fixed at outset and cannot be amended by the trustees at a later date. When selecting the absolute trust, the settlor should be certain of who they ultimately want to benefit from the trust.

The flexible trust names the beneficiaries who are entitled to any trust income. However, if the trust is invested in an investment bond, no income is produced. The trust includes an overriding power of appointment which allows the trustees, which will usually include the settlor, to alter the beneficiaries or their respective shares in the trust. This is especially useful where the settlor may want to alter the beneficiaries in the future. For example, where there are new beneficiaries born after the trust is created, such as grandchildren, or perhaps where the named beneficiary falls out of favour.

Under the discretionary trust, no beneficiary has a right to either income or capital. The trustees are able to appoint income or capital at their discretion to any beneficiary within the class of potential beneficiaries named in the trust deed.

The settlor(s) are generally automatically included as trustees. The settlor(s) should also appoint at least one additional trustee to ensure the validity of the loan agreement. The appointment of additional trustees also avoids the need to appoint replacement trustees after the settlor(s) death.

IHT on the creation of a loan trust:

  • There's no transfer of value for IHT when the loan trust is set up as the settlor loans the money to the trustees rather than gifting it. Therefore there's no PET or CLT on creation.
  • There's no gift with reservation (GWR), provided the settlor’s access is restricted to the repayment of the outstanding loan and they can't benefit from the trust.

NOTE:

  • Growth in the value of the underlying investment, above the amount of the outstanding loan, belongs to the trust.
  • It is not subject to IHT if the settlor dies. 
  • Until the loan has been repaid in full, however, the outstanding balance will still be subject to IHT if the settlor dies.
  • The trustees can repay the loan by taking withdrawals from whatever they have invested the loan in.
  • The trust allows for single or joint settlors; the settlor is not a beneficiary but is entitled to repayment of their loan.
  • The creation of a loan trust is neither a potentially exempt transfer nor a chargeable lifetime transfer because nothing is given away on creation of the trust.
  • This type of trust can be suitable for those who are UK domiciled or deemed UK domiciled for IHT purposes and who can afford to gift away future growth on their capital but may still require full access to the initial capital at some point.
  • A loan trust is ideal for anyone who requires flexibility with regards to frequency and amount of capital repayments but who doesn’t want to create either a potentially exempt transfer or chargeable lifetime transfer.

 

The Pros

> Growth in value is immediately outside settlor's estate
> Assists with inheritance tax concerns (on future growth) while providing a tax-efficient income source and access to capital if necessary
> The amount loaned to the trust will not result in a PET or CLT as no gift is actually made

The Cons

> Amount of outstanding loan will remain within the settlor's estate for IHT purposes
> If you write off the loan, you make a gift at this point. You then setup a PET at this stage.
Why is no PET or CLT created on the creation of the trust?

By using a loan trust you make a loan rather than a gift, as such the assets remain inside your estate for IHT purposes.

How can you establish the loan?

A loan agreement is set up between the settlor and the trustees. Clearly this can only take place after the trust has been created and the trustees have been appointed. It's not possible to lend money to yourself so it's important that the lender and borrower are not the same person, otherwise the loan may not be valid. To ensure the borrower is different from the lender, trustees in addition to the settlor must be appointed at outset.

The amount loaned to the trustees is cash amount and cannot usually be a loan of an existing asset. No interest is charged on the loan and it is repayable on demand either in full or in part.

When can I recall the loan?

Depending on the structure used to hold the investment, up to 100% of the capital loaned to the trust can be redeemed. The growth on the trust, outside of your estate is property of the trust and is not accessible by the settlor.

While setting up the investment, what are the advantages of using a bond?

The trustees invest the amount loaned to them, typically into an investment bond. There are a number of advantages of using a bond:

  • Bonds are non-income producing assets. This means there no tax upon the trustees and income doesn’t need to be paid to any beneficiaries who may have a right to income under the trust
  • There's generally no tax reporting for the trustees until there is a chargeable gain (for example, when the bond or segments are surrendered or withdrawals in excess of the 5% allowance are taken)
  • The 5% withdrawal facility allows regular loan repayments to be made to the settlor without an immediate tax charge
What are the IHT charges for loan trust?

Flexible and discretionary trust loan trusts are subject to IHT relevant property charges.

There will be a periodic charge at each 10th anniversary. The value of the loan trust after deduction of the outstanding loan is used to calculate any periodic charge. Broadly speaking there will be a 6% charge on the value above the available nil rate band.

However, the trustees must complete an IHT100 form if the value of trust without deduction of the loan exceeds 80% of the nil rate band.

There is no IHT exit charge when loan repayments are made to the settlor.

Exit charges may apply when capital is appointed to a beneficiary. There will be no charge on exits made in the first 10 years as there will be no IHT payable when the trust is created.

Will the loan trust come to an end on the death of a settlor?

The trust doesn’t come to an end up on the settlor’s death. The trust will remain until such time as the trustees have appointed all the assets out to the beneficiaries.

On the death of the settlor, any outstanding loan from a loan trust will be an asset of the settlor's estate and therefore potentially subject to inheritance tax.

What are the loan repayment options if the settlor dies?

Alternatively, there are a number of options for dealing with the outstanding loan on death which can be included within the settlor’s Will.

  • Leave it to a surviving spouse. This would be an exempt transfer for IHT and the widow(er) would have the same options for dealing with the loan as the deceased had during their lifetime.
  • Waive the loan to the trust i.e. make a gift of the loan to the trust. This would be a chargeable transfer as the spouse exemption will not apply. The trust would be free from debt and the whole fund held for the trust beneficiaries, leaving trustees free to assign the policy, or segments of the policy, to those beneficiaries as and when appropriate.  
  • Contingency option. A combination of the above two options. The loan could be passed to the surviving spouse if they survive the settlor but otherwise waived in favour of the trust.
  • Gift loan to someone else, such as an adult child. Again, this would be a chargeable transfer on the settlor’s death.

Waiving or gifting the loan in this way avoids the need to surrender the investment bond on the settlor’s death.

Have you used a loan trust?

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Expert assessment of a loan trust

A loan trust can be a useful solution, but whether it is applicable has to be determined on a case-by-case basis, as does the case for using trusts in general.

If you already have a trust structure in place and would like a Second Opinion - or, if you are wondering whether the utilisation of a trust could be of benefit to you, contact us.

 

NOTE: Because trusts are so unique to each individual, it’s impossible to give them a rating for their overall performance and suitability. Therefore these reviews do not come with a star rating.

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