In a previous article, we explored how a Discounted Gift Trust can help reduce an Inheritance Tax (IHT) liability whilst retaining a fixed level of withdrawals for life.
However, not everybody is comfortable giving away capital due to concerns that they may require access to it in the future.
For those who would like to begin passing future wealth to the next generation whilst retaining access to their original capital, a Loan Trust can offer a flexible alternative.
Who should consider a Loan Trust?
One of the most common concerns we encounter when discussing estate planning is uncertainty.
Whilst many people recognise they have surplus assets today, they are often reluctant to give money away permanently due to concerns about running out of money. In addition, future costs and circumstances are difficult to predict.
A Loan Trust can be one way of addressing this concern. It allows assets to be held for the benefit of your chosen beneficiaries whilst retaining the ability to reclaim the outstanding loan, if required.
How a Loan Trust works
A Loan Trust involves lending a lump sum to trustees rather than making an outright gift. The value of the outstanding loan remains repayable to you and therefore remains within your estate for IHT purposes.
However, any growth generated on the assets held within the trust belongs to the trust rather than to you personally. As a result, future growth can accumulate outside of your estate from the outset, whilst still allowing you to retain access to the original capital should it be required.
The trustees can repay the loan to you whenever required, either in stages or in full subject to the trust having sufficient available funds and the terms of the loan and trust documentation. This provides a valuable degree of flexibility, as access to the original capital is retained should your circumstances change in the future.
The structure also allows flexibility if, at a later date, you decide that access to some or all of the outstanding loan is no longer required.
In these circumstances, part of the loan can be waived. The amount waived will generally be treated as a gift for IHT purposes, although the precise treatment will depend on the type of trust and the client’s wider circumstances.
An example in practice
Below is a recent example of advice we have provided. Names and identifying details have been changed to protect client confidentiality.
Susan, aged 73, had accumulated savings and investments over many years but so far in her retirement had relied on her pension to meet her spending needs. Investment growth over the years had meant she was becoming increasingly concerned about the potential IHT liability on her estate. Whilst she wanted to improve the position for her children, she was reluctant to make an outright gift.
This concern was supported by detailed cash flow planning. When we modelled a scenario in which Susan required several years of care home funding, it became apparent that she may need to rely on these savings to help meet those costs.
It was therefore agreed that she would lend £300,000 to the Loan Trust, while retaining £150,000 personally.
Outcomes:
- Susan takes comfort from knowing that the £300,000 loan remains repayable to her should she require access to the capital in the future.
- In the meantime, investment growth is occurring outside of her estate. If the £300,000 grows at 5% net of charges per year, then in ten years’ time, the growth outside her estate would be approximately £188,668.
- Based on these assumptions, the potential IHT saving after 10 years, assuming Susan had not taken any loan repayments, is approximately £75,467, increasing to £129,471 after 15 years.
Important considerations
A Loan Trust is not a complete solution to an IHT liability as the original loan remains within the individual’s estate unless it is repaid and spent or formally waived. Consequently, the IHT benefits are generally achieved gradually through the accumulation of investment growth rather than through an immediate reduction in the estate.
Where the trust invests through an investment bond, withdrawals used to repay the loan may also have income tax implications. The timing and method of any loan repayments should therefore be considered carefully alongside the wider tax position.
Investment performance is not guaranteed and the value of investments can fall as well as rise. Loan Trusts also involve establishing and administering a trust, which may result in costs and ongoing responsibilities for trustees.
The suitability of a Loan Trust will depend on your circumstances, objectives, tax position and wider estate planning needs.
If you would like to explore whether this type of planning could be appropriate for your circumstances, or understand how it fits alongside your wider financial plans, we would be happy to have a conversation with you. Existing clients can contact their adviser, and new enquiries are welcome via the contact form below.
