A loan trust is a trust that allows for a potential reduction in Inheritance Tax (IHT) over time while enabling you to retain access to the original capital invested. Rather than giving up complete access to your funds, you only give up access to the future growth of those funds to your trustees.
With a loan trust, an individual lends a sum of money to the trustees of a trust that has been established with the specific purpose of receiving a loan. The trustees then use the loan to invest in a bond that is held by the trustees for the beneficiaries. However, the lender (who is also the settlor of the trust) retains the right to have their loan repaid at any time.
As this is a loan and not a gift, there is no immediate reduction in the settlorʼs estate for IHT purposes.
However, any growth in the value of the investment will be outside the settlorʼs estate for IHT purposes and held for the beneficiaries under the trust.
When you pass away, any remaining loan amount becomes repayable to your estate. The remaining funds within the trust (representing the growth), can then be distributed to the trust beneficiaries free from Inheritance Tax.
You can arrange for your rights to the loan to be waived on your death – either by including a clause in your will or, in some cases, by making this choice when setting up the trust. If you do this, the trustees will not have to repay the loan to your estate; instead, the value of the loan stays in the trust for the beneficiaries. However, waiving the loan in this way does not remove its value from your estate for IHT purposes – the amount waived is still counted as part of your estate when calculating IHT on death.
Repayments often use the 5% tax-deferred withdrawal feature of investment bonds. Meaning you can get money back without paying Income Tax straight away, as long as you stay within the 5% yearly limit.
You can give away part or all of your outstanding loan if you no longer need access to it by waiving your right to some or all of the loan or gifting your right to the loan to someone else, helping reduce the value of your estate for Inheritance Tax, after seven years.
With any trust involving life assurance policies, it’s essential that you appoint at least one additional trustee to act with you during your lifetime and to deal with the trust after your death.
HMRC confirms this arrangement is exempt from the pre-owned asset taxation regime, so no tax applies when setting up the trust since its value excludes outstanding loans.
However, discretionary loan trusts may face two potential future charges: a ten-year periodic charge of up to 6% on the value exceeding the trust’s available nil rate band (currently £325,000), and an exit charge of up to 6% when money is distributed to beneficiaries. Both charges are unlikely if investment growth remains modest. Regular payments to you are exempt from the exit charge.
A loan trust is an arrangement where you lend money to a trust while retaining the right to repayment of your original capital. The growth in the trust is outside your estate and not subject to Inheritance Tax; the original loan remains in your estate for IHT purposes.
A loan trust allows you to access your original capital but not the growth. A discounted gift trust provides a regular fixed income but you cannot access your original capital. With a loan trust, the Inheritance Tax benefits build up more slowly as they only relate to the growth on the investment.
No. HM Revenue & Customs has confirmed that this type of arrangement is not subject to the pre-owned asset taxation regime, which was introduced to stop the practice of giving away assets to avoid Inheritance Tax while enjoying the benefits of said assets.
A loan trust is relatively slow in achieving Inheritance Tax benefits as they only come from the growth of the investment being outside your estate. The longer the investment growth has to accumulate, the greater the potential Inheritance Tax saving.
Yes. As the settlor, you can request repayment of the whole outstanding loan, or a part of it, at any time. Repayments can be made as regular instalments (e.g., monthly, quarterly, annually) or as occasional lump sums, depending on the settlor’s preference and needs. However, for optimal tax planning, repayments are structured to use the 5% tax-deferred withdrawal facility available on investment bonds, allowing you to receive repayments without an immediate Income Tax charge, provided withdrawals stay within the cumulative 5% allowance.
The trustees have control over the trust and making distributions to the beneficiaries, so you should select people who you trust to carry out your wishes.
Yes, it’s essential you appoint at least one additional trustee to act with you during your lifetime and to deal with the trust after your death when using any trust involving life assurance policies.
Yes. We can provide advice on the trust establishment and ongoing investment management, although we would recommend you receive independent specialist legal advice on the trust itself.
Yes, provided the trust has been registered with the Trust Registration Service (TRS). If you’re already a client of ours, you should speak to your consultant. If you’re new to Mattioli Woods, book your complimentary appointment here.
