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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.
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:
Steps involved in creating a loan trust:
Typically the creation of a loan trust requires the following steps.
These are typically all packaged together and included in the provider’s documentation.
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:
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:
By using a loan trust you make a loan rather than a gift, as such the assets remain inside your estate for IHT purposes.
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.
The trustees invest the amount loaned to them, typically into an investment bond. There are a number of advantages of using a bond:
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.
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.
Alternatively, there are a number of options for dealing with the outstanding loan on death which can be included within the settlor’s Will.
Waiving or gifting the loan in this way avoids the need to surrender the investment bond on the settlor’s death.
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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.
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.