Inheritance Tax  

How to help clients with loan trusts and inheritance tax planning

  • Explain how a loan trust is structured
  • Explain in what circumstances a loan trust is suitable for
  • Explain the benefits and risks of a loan trust
How to help clients with loan trusts and inheritance tax planning
c: EPA / Andy Rain

Inheritance tax receipts are on the rise. HM Revenue & Customs data show that £3.6bn was collected in IHT receipts between April and October 2021, a 20 per cent increase on the same period a year earlier. 

If the trend continues it will be another record year for IHT receipts. 

One contributing factor to the increase in IHT receipts is likely to be the soaring housing market. 

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The other often overlooked factor is the freezing of the nil rate band since 2009.

The IHT nil rate band and residence nil rate band will remain frozen at £325,000 and £175,000 through to the end of 2025-26, regardless of what happens to house prices.  

As estate values increase, the need for IHT planning is greater than ever. 

Advisers that understand the market and can give relevant IHT planning advice will be able to add significant value to their clients.  

Loan trusts 

Some clients may not wish to give outright gifts but instead want to retain the right to access their funds in the future if they need to use it. This is where loan trusts can come into play.

Loan trusts can be particularly suitable for clients who want:    

  • to plan their IHT but require access to their original capital;
  • flexibility from a trust where they can waive loan amounts at any time should they no longer require all of the monies back; and
  • flexibility where they can take any amount, up to the original loan, at any time should they wish.

How a loan trust works

A loan trust provides a client with medium to long-term IHT planning and access to their original capital at any point in the interim. 

It is a lump-sum IHT planning scheme, consisting of three components:

  • a trust;
  • a loan; and
  • an investment – usually a single premium investment bond.

The settlor makes an interest-free loan to the trustees, which is repayable to the settlor on demand.

The outstanding loan balance remains as an asset of the settlor’s estate while any growth is held outside the estate for the benefit of the trust beneficiaries.

On occasion, the settlor may demand a part repayment of the loan. 

The trustees would usually make part surrenders within the cumulative 5 per cent tax-deferred allowance available to bonds to make ad-hoc loan repayments back to the settlor.

Over time, as repayments are made (and spent), the value of the outstanding loan (and consequently the estate) reduces while the amount outside the estate increases.

Any loan repayments made to the settlor and spent reduce the amount in the estate.

The outstanding loan remains in the settlor’s/donor’s estate for IHT purposes. But future growth will not be included in the client’s estate for IHT purposes. 

How is a loan trust structured?

It is very important to get the order correct when you are setting up a loan trust. 

The trust must be created first. You can set one up on either an ‘absolute trust' or ‘discretionary trust’ basis. 

The settlor selects the beneficiaries and potential beneficiaries of any bond growth. 

The settlor then lends monies to the trustees who in turn buy the bond. 

It is generally acceptable to have the same date on the trust and the application form, as the assumption will be that the trust was created earlier in the day, before the application.