Loan Trust

loan trust

This page was last updated on 1 June 2021

Loan Trust In 2021

Topics that you will find covered on this page

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Why is inheritance tax planning important?

For many people, it is important to be able to leave money to your children and grandchildren after their death.  However, the amount you can pass on is reduced by the amount of inheritance tax you have to pay to HMRC. If you reduce the amount of inheritance tax your estate is liable to pay, this increases the amount you can leave to your family and loved ones in the future. 

How much is inheritance tax?

In the UK, there is a nil rate band of tax, and you do not pay tax on the value of your estate beneath this. Any value of your estate worth over the nil rate band, which is currently £325,000 is taxed at a rate of 40%. There are different caveats for certain types of assets, like a family home and certain types of outright gifts. Saving this money can benefit your inheritance.

What does a loan trust do?

When you put your capital into a loan trust, you can access it at any time in the future. However, the investment growth of the trust fund will not be counted as within your estate. This means it will not be considered when inheritance tax is calculated. 

Why would you consider getting a loan trust?

The idea is to gradually lower the value of the settlor’s estate on death is not taxable, but then the settlor can access the sum. Further, you can make your money grow through investments, often with a single premium bond or life assurance bond.

Who is a loan trust for?

People who use loan trusts are those who want to keep a level of control over their original investment. This might be because you cannot afford to give away your assets in full, but still want to reduce the IHT payable on your taxable estate. 

Who is eligible for a loan trust?

There is no point in getting a loan trust if your estate is worth than £325,000 which is the nil rate band, as if it is worth less than this your estate is not taxable anyway. Also, you must have the original capital available to make the investment, and for absolute trusts, you must know the beneficiaries you want to benefit from your estate. 

How does a loan trust work?

As the name implies, once the trust fund has been set up, you, the settlor, will lend your capital to the fund. Then, the amount you have loaned is invested into an investment bond, probably a single premium bond. The value of the loan is repaid, most commonly in instalments. 

discretionary loan trust

Why are loan trusts good for inheritance tax planning?

Any growth from the trusts’ investment bond will not be part of your estate. Therefore, when it comes to your estate being assessed for inheritance tax purposes, the value of your estate will be lower, therefore the amount of your estate lost to tax will be less. 

What are the benefits of loan trusts?

Beyond IHT, the settlor gets to keep their original loan, and it can be repaid to them on demand at any time. Also, you make money from the bonds. 

"When you put your capital into a loan trust, you can access it at any time in the future. However, the investment growth of the trust fund will not be counted as within your estate. This means it will not be considered when inheritance tax is calculated. "

What are the potential loan repayment options?

The settlor can get repayments in regular instalments, in a lump payment or as repayments at occasional intervals. The settlor and the trustees can agree how regular loan repayments will work when they create the trust fund. 

What types of loan trust can I get?

There are two available trusts, a discretionary trust and an absolute trust. The purposes are slightly different.

What is meant by an absolute trust?

An absolute trust is where who the beneficiaries are and what share of the trust they are entitled to must be determined when the trust is set up.

What are the financial consequences of an absolute trust?

From a tax planning perspective, for a fixed loan trust the capital growth is out of your estate, it belongs to the trust. The entire trust is not liable to pay period inheritance tax or an exit charge. However, each beneficiary’s share of the value of the trust is considered part of their own estate. 

What are absolute beneficiaries entitled to?

The beneficiaries are entitled to demand access to the value of the fund growth whenever they want past the age of 21. They are not entitled to the outstanding value of the trust. The trustees can use the investment growth for the benefit of or the maintenance of the beneficiaries. 

What is a discretionary loan trust?

This is where the settlor is able to change who the beneficiaries are and what share they are entitled to. However, it is important to consider that discretionary trusts are still subject to a tax charge.

What are the trustee responsibilities for a discretionary trust?

The trustees the settlor selects get to choose who gets to benefit out of the trust and how much of the future growth the beneficiaries get. This is as long as the beneficiaries they choose are part of the class of trust beneficiaries stipulated in the trust deed. 

What are the tax consequences of a discretionary trust?

A discretionary trust is normally subject to periodic inheritance tax payments and an inheritance tax exit charge. This means every 10 years, tax will be charged on any capital growth on the investment at the 10 year anniversary. This is called a 10 year anniversary charge.

How does the 10 year charge work?

If the value of the trust on the 10 year anniversary is above the nil rate band, which is £325,000 at the time of writing, then a periodic charge will be due. The nil rate band will be less if capital payments have been made subject to exit charges in the initial 10 years of the fund.

Also, if the settlor has made a IHT- chargeable lifetime transfer through gifts over a certain level in the 7 years before making the trust, this will reduce the nil rate band. 

What is the exit charge?

This applies if beneficiaries are paid out of the trust. If the trust value is beneath than the nil rate, in the first 10 years the charge on exits rate is 0%. For payments made after the first 10-year anniversary, the rate follows that at the 10-year anniversary rate. Repaying the loan is not considered an exit payment.

How can you optimise making potentially exempt transfers with a loan trust?

If you have waived an amount of the loan, this could be a potentially exempt transfer. In other words, if the settlor lives more than 7 years, the amount is not taxable. However, on a sliding scale, inheritance tax is due if the settlor dies less than 7 years from making the transfer. 

Can the beneficiaries of absolute loan trusts demand their trust share?

The beneficiaries of the loan trust arrangement can demand their trust share and must be made aware that the trust exists. This can be a problem if one of the beneficiaries goes bankrupt or gets divorced, as the trust fund forms part of their estate. 

Can the settlor take any control over how the trust funds are divided between beneficiaries?

Trustees can allocate however much they want to whichever beneficiary they want, as long as they fall within the class of beneficiaries. However, unlike an absolute trust, the beneficiaries cannot demand that the trustees give them money, and the estate is not impacted by if the beneficiaries get divorced or go bankrupt. 

What happens if a beneficiary passes away?

Where an absolute beneficiary dies, then the trustees have to consider the beneficiary’s will. The beneficiaries are only entitled to the fund, not the outstanding loan. 

How do chargeable lifetime transfers apply to chargeable lifetime transfers?

Any loan that is waived is a chargeable lifetime transfer, so there might be an entry charge, depending on the value of what has been waived. 

What are the possible problems with loan trusts?

There are disadvantages to loan trusts, including:

  • The settlor is not entitled to the growth from the investment. 
  • An investment is not a sure thing, and there is potential for the value to go down. 
  • If you can make a gift to the trust, this is better for inheritance tax. This is because the amount that has not been repaid when you die is part of your estate, so is still considered for IHT. 
  • The benefit that the settlor gets from the trust will cease after the loan is paid off and so they will no longer get trust income. 

What kind of transfer is a loan trust?

The loan is not a chargeable lifetime transfer, nor is it a potentially exempt transfer. As a result, it will be considered a part of your estate even after 7 years have passed. 

Can the loan be waived?

Loan trusts are a very flexible arrangement, and so the loan that remains outstanding can we waived in full or on part at any point. Often settlors will waive £3000 a year to make the most of the annual exemption. Also, if individuals decide that they do not need the outstanding loan anymore they can waiver lump sums for the beneficiaries.

What clauses should go into the trust deed?

You should pay careful consideration to the trust wording as this can impact the trust IHT and the beneficiaries’ rights. It is a good idea to include a clause stating that repayment is waived if the loan is not fully paid back when the settlor dies.

What if I want to give away some of the value of the trust during my lifetime?

Gifts you make out of the outstanding loan will have inheritance tax consequences. If you want to do this, it is a good idea to speak to a financial adviser. 

What if you no longer need the outstanding bit of the loan?

If you want to, you can choose to waive the outstanding loan in part or in full. This might classify as a chargeable lifetime transfer or a potentially exempt transfer. You should get financial advice before doing this. Once your loan has been fully repaid, you will not be able to get any more payments from the trust. 

When is income tax payable?

Trustees can take out a maximum of 5% of the original investment without having to pay income tax. If the bond is surrendered or partly surrendered, there might be a gain that is subject to tax. However, where a UK bond is used, the gain comes with a tax credit that covers the basic tax rate liability. 

Who pays income tax on an absolute trust?

The gain is considered as part of the beneficiaries’ income, so will be charged at their highest marginal rate. 

Who pays the income tax on a discretionary trust loan?

If the settlor is still alive and lives in the UK, the gain is considered part of their income so will be charged at their highest marginal rate. If the settlor has died, or is not living in the UK, tax will be assessed based on UK resident trustees. 

What kinds of investment should the trust fund make?

This can be any kind of investment, but if income comes from the underlying investment, it could be taxed. As such, a single premium bond is most commonly used for loan trusts, but you should get financial advice. Clearly, you should choose a bond with potential for growth, though as with any bond the growth rate is not guaranteed.

Who should be chosen as a trustee of a loan trust?

The settlor normally appoints themself and someone else they trust and respect. One of the trustees can be a professional. The trustees have to make decisions unanimously, so it is a good idea to make sure your trustees get on. 

Why is a good idea to get professional advice to set up a loan trust?

There are multiple reasons it is a good idea to get professional help to set up a trust:

  • To develop an understanding of the legal consequences and tax consequences of establishing a trust. 
  • Sometimes another type of trust is better suited to your estate, and an adviser can help their client weigh up their options, considering their long-term planning objective
  • Certain withdrawals can trigger income tax, so an adviser can help the client avoid these
  • Trustees have duties to both the settlor and the beneficiaries. Mismanaging these duties can make the trustee personally liable for the losses. 
  • You are more likely to need professional help where more than one jurisdiction is involved, as this can be even more complex. 

How much does financial advice cost?

There will be a charge for setting up the trust fund and for the ongoing advice to the client. To find out more, you should contact an adviser for a quote. 

Would you like some help to set up Loan Trust?

You can contact us in one of 3 ways:

  • Option 1 – Call us directly on – 0333 567 1602
  • Option 2 – Book an appointment directly in the calendar below, and one of the team will call you back at the chosen time
  • Option 3 – Leave us your contact details and we will get in touch

 

Option 1 – Call directly to discuss your Trust needs

Our lines are open Monday to Friday – 9:00 to 5:00

Option 2 – Book an appointment, in the calendar below, for a Trust specialist to call you back when its convenient

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Option 3 – Leave us your details and we will get in touch

Leave your contact details below and one of the team will give you a call to discuss your needs.

Please note that all calls are undertaken by Quadrant Estate Planning.

Article author

Katy Davies

I am a keen reader and writer and have been helping to write and produce the legal content for the site since the launch.   I studied for a law degree at Manchester University and I use that theoretical experience, as well as my practical experience as a solicitor, to help produce legal content which I hope you find helpful.

Outside of work, I love the snow and am a keen snowboarder.  Most winters you will see me trying to get away for long weekends to the slopes in Switzerland or France.

Email – katy@helpandadvice.co.uk

LinkedIn – Connect with me

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Life Interest Trusts

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Asset Protection Trusts

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Home Protection Trusts

Protecting assets in a trust is a good option for wealth management and getting control over who inherits from your estate.

Inheritance Protection Trusts

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Estate Planning & Trusts

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Frequently Asked Questions

What does a loan trust do?

When you put your capital into a loan trust, you can access it at any time in the future. However, the investment growth of the trust fund will not be counted as within your estate. This means it will not be considered when inheritance tax is calculated.

Why would you consider getting a loan trust?

The idea is to gradually lower the value of the settlor’s estate on death is not taxable, but then the settlor can access the sum. Further, you can make your money grow through investments, often with a single premium bond or life assurance bond.

Who is a loan trust for?

People who use loan trusts are those who want to keep a level of control over their original investment. This might be because you cannot afford to give away your assets in full, but still want to reduce the IHT payable on your taxable estate. 

Who is eligible for a loan trust?

There is no point in getting a loan trust if your estate is worth more than £325,000 which is the nil rate band, as if it is worth less than this your estate is not taxable anyway. Also, you must have the original capital available to make the investment, and for absolute trusts, you must know the beneficiaries you want to benefit from your estate.

 

 

Would you like some help to set up a Loan Trust or have questions about the types of trust you can use?

You can contact us in one of 3 ways:

  • Option 1 – Call us directly on – 0333 567 1602
  • Option 2 – Book an appointment directly in the calendar below, and one of the team will call you back at the chosen time
  • Option 3 – Leave us your contact details and we will get in touch

 

Option 1 – Call directly to discuss your Trust needs

Our lines are open Monday to Friday – 9:00 to 5:00

Option 2 – Book an appointment, in the calendar below, for a Trust specialist to call you back when its convenient

Option 3 – Leave us your details and we will get in touch

Leave your contact details below and one of the team will give you a call to discuss your needs.

Please note that all calls are undertaken by Quadrant Estate Planning.

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