What is a Loan Trust?

The inheritance tax ‘gift with reservation’ rules make it difficult for you to achieve an inheritance tax saving whilst retaining an income or benefit from your assets.

A Loan Trust resolves this issue as it is designed to envelope a loan that is repayable on demand. You make a loan to your trustees who invest this in a single premium investment bond written in trust for the ultimate benefit of your chosen beneficiaries. As the bond grows in value the growth falls outside your estate for IHT purposes. As the interest free loan is not a gift for IHT purposes there is no potential IHT charge on setting up the trust.

The trustees can make withdrawals from the investment bond in order to repay the loan to the Settlor over a period of time. This can be on a regular or ad hoc basis depending on your requirements.

On death or earlier encashment of the bond, an additional tax charge may be incurred and these are covered in the attaching Appendix. It may however be possible to limit tax charges by assigning segments or policies to basic rate or non taxpayers who would face a lower tax charge on encashment.

At any time you could forego the outstanding loan, by doing this you would forego access and be making a gift for inheritance tax purposes. It must be noted that if the value of the fund falls and the loan is called in to a level where it would not meet repayment, the trustees can be held accountable for the shortfall. It is also the trustees’ responsibility to cease withdrawals from the policy once the outstanding loan has been repaid.

The establishment of the loan trust will not create a charge to pre-owned asset tax because apart from the repayment of the loan the settlor the settlor is expressly excluded from benefitting from the trust.

To summarise, the plan has the effect of reducing inheritance tax by ensuring all future growth on the investment is outside your estate. It also enables you to receive a regular ‘income’ throughout the term of the loan. The loan may be called in at any time and any investment growth distributed to the beneficiaries.

The Loan Trust usually incorporates a discretionary trust and is used with a view to reducing an individual’s inheritance tax liability. It is designed to work as follows:

• The investor makes an interest free loan to the trust which the trustees then use to purchase a single premium investment bond.
• Income can be provided to you, the Settlor, by the trustees. These income payments are deemed to be a return of the initial capital investment and will be used to reduce the outstanding loan.
• Income withdrawals of up to 5% per annum can be made for 20 years without any immediate personal tax liability.
• When the investor dies, the bond value may be paid to the trustees. This is free of IHT as it is outside the estate. The balance of the loan outstanding is paid to the investor’s estate, where it is subject to IHT. Any higher rate liability due on a chargeable gain is payable by the estate at the investor’s marginal rate of tax.
• The outstanding loan is repayable on demand by the trustees to the investor. Once the trustees have fully repaid the loan they can make no further payments to the investor.
• It is possible to write the bond in joint names and therefore it will continue until the death of the last of the lives assured. Further lives assured can be added at the outset, for example, the beneficiaries of the trust. This gives the trustees the ability to defer finally cashing-in the bond until the most opportune time, with the aim of reducing any income tax charge which arises on the gain.