Inheritance Tax Planning and Trusts  
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Avoiding Inheritance Tax

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IHT - How To Mitigate: Loan Trusts


A Loan Trust (Or A Gift And Loan Trust)

A Trust is set up by an individual, either with a small gift of, typically £3,000 i.e. an amount equal to the Annual Gift Allowance, or on the promise of the loan to be made.  The trustees are then granted an interest free loan. 

Let us assume that the loan made is £100,000.   What are the benefits of doing this, what advantages does it give and just as importantly, what drawbacks does it have?

Benefits

Whilst the full amount of the outstanding loan will always remain in the Settlor’s (the person that set up the trust and lent it the money) Estate, any growth on the trust assets will be outside of the scope of IHT.  However, the Settlor can always ask for the loan to be repaid so they have not given away the capital, only the growth on the capital. 

Let us assume that the Settlor dies after 10 years and the investment has grown at 6% p.a. (in this example we shall not consider any tax liabilities other than IHT, but of course they do need to be taken into account.  We shall also assume that none of the £100,000 loan has ever been repaid.  After 10 years, the value of the trust’s investment would be worth £179,085, but of course they would have to repay the outstanding loan of £100,000 to the Estate of the deceased Settlor.

The deceased’s estate would have to pay IHT at 40% on the value of the loan repaid, i.e. £40,000.  However there would be no IHT liability on the £79,085 remaining in the Trust.

This means, that after 10 years the £100,000 would have resulted in £139,085 being available on the Settlor’s death, £79,085 in the trust and the £60,000 repaid loan after the IHT liability has been paid.

However, if the loan trust has never been set up and the £100,000 and the growth on it had all remained in the Estate the IHT liability would have been £71,634 resulting in only £107,451 being available on the “Settlor’s” death.

Thus the “Loan Arrangement” has resulted in an IHT saving of £31,634.  Thus it effectively freezes the IHT liability as any growth on the loan is not liable to IHT on the Settlor’s death, although it may be liable to other taxes within the trust.

Advantages

The main advantage is that the Settlor has full access to any amount of the loan that is outstanding.  This means that at any point the £100,000 loan can be called in either as a one off repayment or in a number of instalments, but these should not be regular.

Disadvantages

The main disadvantage is that the Settlor is giving away any growth on the loan.


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