A Study Of Gifting: Loan Trusts

The changes announced in the autumn Budget to the tax treatment of pension death benefits from April 2027 means a number of people are going to have to consider a change to, or the establishment of, inheritance strategies to ensure the tax efficient passing on of wealth to intended beneficiaries. For many, pensions have provided the ideal solution for such wealth transfer, but the inclusion of ‘unspent’ funds within the estate from April 2027 means advisers will need to help clients decide the best way to achieve their inheritance planning aims.

How it works

The idea of gifting and use of trusts can be off-putting to many who see loss of access and legal costs as reasons to avoid any action, but there is an option that can provide a start and help clients overcome their inhibitions.

It is possible to establish a trust making a loan to the trustees rather than making a gift. So there has been no transfer of wealth for IHT purposes as the loan is still within the client’s estate, but any growth on the loan amount in the trust is immediately free from IHT thus capping the tax liability to the loan amount. If the loan had not been made then the full amount, including the growth, would be in scope for IHT purposes.

The loan is on an interest free basis and can be recalled in part or in total by the donor at any time giving the donor continued access to the original investment in case they need to call on it.

Over time, however, the donor may decide that they no longer need access to all or any of the loan amount and so can give it away. This could be to the trustees of the loan trust or another individual who would then take over as the lender with the loan now being in their estate. This gift by the original donor will be a potentially exempt transfer (PET) if made to the trustees of a bare trust or to an individual and will not be out of the donor’s estate for seven years. If the recipient trust is on a discretionary basis then the gift will be a chargeable lifetime transfer (CLT) and count against the original donor’s nil rate band (NRB) with an IHT entry charge due on any amount, when added to any other CLTs made in the previous seven years, in excess of the NRB. If the client is not using their £3,000 annual IHT exemption elsewhere, gifting the loan using this allowance would be a tax-efficient way of gradually gifting the loan over time without the need to wait seven years for the gifted amount to pass out of their estate.

On the death of the donor, any outstanding loan will be included in their estate. Their will may include a provision that details what should happen to the loan. For example, it is to pass to a surviving spouse or civil partner, or the loan could be waived and so become part of the trust fund. In the former case the loan would pass IHT free under the spousal exemption, but the exemption would not apply under the latter.

Trustee investment

An investment bond, in our view, is ideally suited as investment property for a loan trust. The 5% tax deferred withdrawal limit in the bond provides a way for the donor to receive regular payments from the trust without generating a tax liability at time of the withdrawal. Distributions can be made from the growth portion of the trust (plus any amounts of the loan gifted by the donor) to beneficiaries either by the trustees surrendering the required amount of the bond or by assigning segments to the beneficiaries.

If the trust is a bare trust, tax on any chargeable gain will be payable by the beneficiary. For discretionary trusts, the donor is responsible for paying the tax during their lifetime or in the tax year of their death, and subsequently to the trustees. Alternatively, assigning segments of the bond to the beneficiaries means gains will be liable to tax at their rate of income tax rather than the trustees’ rate, which is 45% on anything above £500 in a tax year. The beneficiary can also use top slicing relief to mitigate any higher or additional rate liability on the gain – trustees cannot do this.

If the bond is written with multiple lives assured, this will enable the trustees to control how and when benefits are distributed, and tax is payable.

It should be noted that assignment of segments to the donor to repay the loan will be treated as a chargeable event for money’s worth and may give rise to a chargeable gain.

All information is based on our understanding and interpretation of applicable law and regulation.

 

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