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How Loan trusts can be used to plan for inheritance tax, school fees, pensions and death benefits.
Loan Trusts can be used for a variety of planning strategies.
Inheritance tax (IHT) planning
Planning strategies involving Loan Trusts are suitable for the ‘conservative’ investor who wants to avoid inheritance tax but doesn't want to make significant outright gifts at inception. Setting up a loan trust does not give rise to a transfer of value for IHT purposes (i.e. there is no initial gift).
Consider subsequently using loan ‘waivers’ to utilise the inheritance tax annual exemption. These may be appropriate where the investor is confident that he/she no longer needs access to the full outstanding loan balance. Larger waivers will be gifts subject to the seven year rule. These larger gifts will give rise to a chargeable lifetime transfer in the case of a discretionary loan trust and a Potentially Exempt Transfer for a Bare loan trust. Loan waivers must be made by way of deed.
Be aware that with a joint settlor arrangement, both settlors are permanently excluded from benefitting from the growth. Consider using two single settlor arrangements if each ‘party’ has his/her own funds. In that event, after first death the survivor may be able to benefit from the growth from the trust established by the first to die, at the discretion of the trustees.
The trustees need to invest to maintain capital as the trust fund should be at least equal in value to the quantum of the loan. The trustees could be personally liable for any shortfall. A trustee shall not be liable for a loss to the trust fund unless that loss was caused by his/her own fraud or negligence.
Bare/absolute trust structures lack the flexibility of discretionary trust arrangements.
School fees planning
A Loan Trust could be used for school fees planning. A Loan Trust is established – an initial IHT planning step for settlor. The trustees can then advance amounts (from the growth on the bond) to beneficiaries to meet school fees. The amounts advanced would normally be within the bond's cumulative 5% allowance. Strategies involving assignment of bond segments to beneficiaries should also be considered.
Lump sum pension death benefits
A Loan Trust could be used as the ‘home’ for pension scheme death benefits. The scheme member would usually provide the scheme administrators/trustees with a letter of wishes. Following the member's death before vesting the Loan Trust would operate as a 'bypass' trust.
The trustees could use their power of advancement to make pension contributions for beneficiaries.
On 7 November 2018, HMRC issued a consultation document “The Taxation of Trusts: A review”. In simple terms, the consultation sets out the government’s thinking on making trusts fairer, simpler and more transparent. At the time of writing, the government is not making specific proposals for reform. Instead, the government will weigh up the views and evidence presented and consider the options for targeted reforms.
On 23 November 2018, the Office of Tax Simplification published its First Report regarding its review of the IHT regime. This concluded that too many people have to fill in IHT forms, with the process being complex and old fashioned. The recommendations therefore relate to administrative issues. The second report covering wider areas of concern (technical and design issues) was published in July 2019.