Trusts School Lesson 6 Q&A

Q. Loan Trust - if beneficiary is 40% or 45% taxpayer, and so pays those rates on chargeable gains, is the fact the loan trust growth saves 40% IHT negated by the tax the beneficiary pays on the chargeable gain?

A. This would not be my interpretation.

You must remember that the client would still need a tax wrapper, even if they weren’t using a loan trust. So if they were using an investment bond without a loan trust, they would be paying IHT at 40% on investment growth, and then their beneficiaries would also potentially be paying income tax on the chargeable gain.

Separately, with good planning it should be obtainable for the vast majority of bond gains to be extracted at basic-rate tax, or perhaps lower. Therefore, we think the number of people who will be paying 40% or 45% tax on bond gains will be quite small.

Q. Gift and Loan - If you give the "growth" to the beneficiaries do you gift segments or make a gift across all segments. If segments are gifted there will be less remaining and this will mean that the initial loan cannot be repaid from the 5% tax deferred. Is there a chargeable gain in the bond?

A. It needs to be looked at on a case by case basis. Options are for trustees to make a withdrawal across segments, fully encash segments or assign/appoint segments in favour of a beneficiary. Partial withdrawals to make use of the tax deferred allowance could be useful if the intention is to avoid triggering a gain. Whether you encash segments within the trust or assign to a beneficiary depends on the type of trust i.e. absolute or discretionary and the tax position of the parties involved. With an absolute trust any gain within the trust is probably going to be assessed on the beneficiary so assigning makes no difference. With a discretionary trust, gains could be assessed on the settlor if alive and UK resident in the tax year the gain arises whereas assignment would take advantage of the beneficiary’s tax position.

Q. Reversionary v gift trust = long term care concerns...

A. This is true, a reversionary trust does provide clients with some reassurance that they can access funds in the future if required.

Q. If a Will Trust sets up a Discretionary Trust with a tenants in common house in it. Allows the surviving unmarried partner to live there, but they aren't a named beneficiary of the Will Trust. Is the survivor a Life Tenant? Would they have access to income if the house is sold and funds invested?

A. This is a complex issue which highlights the difficulties of trying to use the family home as part of IHT planning. Definitely one for legal advice as the partner’s rights under housing law might be different from their rights under the trust. If the partner still owns half the house, it would be unlikely that the house could be sold without their consent.

Q. Who is liable to repay the outstanding loan on a loan trust if the value is lower than the original loan?

A. Life company loan trusts will usually have a shortfall clause. This means that if the value of the bond has fallen below the value of the loan due to fund performance, the trustees will not need to repay the full loan amount to the settlor.

However, if the loan cannot be repaid due to injudicious actions by the trustees, for example, advancing too much capital to the beneficiaries, then the trustees will usually be liable for any outstanding loan.

Q. For gift trust, you could die in less than 7 years - so gift may fail?

A. Yes, assuming the gift into trust is not exempt, if you die within 7 years the gift would fail. Failed gifts in the 7 years before death use up the deceased’s nil rate band in chronological order. Where they are covered by the nil rate band, no tax is due. Any gifts in excess of the nil rate band will be subject to IHT.

Q. Isn't a Loan Trust more reliable than a gift trust to work as expected/manage inherent risks? There's no 7 year clock and the periodic charges can be mitigated via Rysaffe

A. I don’t think a loan trust is necessarily in a different position to a gift trust when it comes to how likely it is to perform as expected.

I agree there is no 7 year clock because the outstanding loan remains in the settlor’s estate so I suppose if they changed this to 10 years for example, a gift trust could be impacted more than a loan trust.

While you can mitigate periodic charges for loan trusts, any changes to the periodic charge calculation would apply equally across discretionary loan and gift trusts.

Q. Assuming everyone is in agreement, what are the implications of collapsing a DGT and paying the fund to the beneficiary?

A. The settlor of a DGT can waive their right to future withdrawals but it’s not as simple as the trustees stopping the regular withdrawal instruction on the bond.

Generally the settlor(s) would need to give up their rights by deed and a solicitor might be required to draft the deed. Giving up their rights would also be deemed a further potential exempt transfer (PET) or chargeable lifetime transfer (CLT) if it’s an absolute or discretionary DGT respectively. To calculate the PET or CLT, underwriting and actuarial expertise will be required and this is likely to come at a cost, rather than a free service provided by the DGT provider.

The key point is to make sure you set withdrawals at a suitable level at outset or don’t do a DGT at all if they don’t need any withdrawals!

Q. Is the normal recommendation to set up an investment in trust to utilise NRB and RNRB before making outright gifts directly to children/grandchildren etc.

A. If setting up a discretionary trust and making an outright gift (a potentially exempt transfer) at around the same time there is a generally accepted order of gifting. You set the discretionary trust up first and then make your outright gifts. The reason for this is because the trusts nil rate band for periodic and exit charges is reduced by chargeable transfers in the 7 years before the trust is set up. While a successful PET will not reduce the trust’s nil rate band, a failed PET does. By making your PET after setting up the trust, even if the PET fails, there is no impact on the trust’s nil rate band.

You cannot use RNRB (or any inherited bands) with lifetime gifts.

Q. What are the main considerations when thinking about whether a joint DGT or 2 separate DGTs will be suitable for a married couple?

A. There are various considerations to take into account in deciding whether two single settlor DGTs are more appropriate than a joint DGT.

Where the DGT is set up on absolute basis the main thing to consider is whether you want the full amount of withdrawals to continue until second death or not. If you do want the withdrawals to remain at the same level a joint DGT would be more suitable as the withdrawals from the deceased spouse’s DGT would cease on their death.

If you are setting up a discretionary trust then you are likely to get a larger discount using a joint settlor arrangement as opposed to two single settlor trusts however, this should not be the deciding factor. Single settlor DGTs are likely to be more flexible because although withdrawals will cease on the settlor’s death, the surviving spouse is usually going to be a potential beneficiary of the deceased’s trust. This means that even though the “income” for the surviving spouse has reduced, they could still potentially top this up from the deceased’s trust if required (at the trustees’ discretion). This can be useful as expenditure will likely change when one of the couple dies so the withdrawal level that was appropriate when they are both alive, may not be after one of the couple has died.

Tax wise with a joint settlor DGT if you go beyond twenty years and one settlor is deceased there will be annual gains taxable at the trust rate.

Our general view is two single settlor trusts should be the default position unless you can think of a reason that they were not going to be troublesome.

Q. What about taking excess withdrawals from a pension to put into a gift trust? Does that work?

A. You can make withdrawals from your pension and gift this into a gift trust. If the pension income generated is surplus to expenditure requirements then the gifts may qualify under the normal expenditure out of income exemption. You would need to consider all the criteria that need to be met for the exemption so the gifts would need to be “normal” i.e. a pattern of gifting is established and the gifts should be similar in size.

Q. Although premiums can be offset against normal expenditure to WOL, How are they treated for exit charges & 10 year charges within Discretionary trust.

A. The normal expenditure out of income exemption can stop entry charges, but you are right in saying they don’t provide an exemption against periodic and exit charges.

However, we think that Rysaffe planning can be used for large WOL cases and this has the potential of eliminating or significantly reducing the impact of periodic/exit charges.

Q. For Whole Life in Trust, what is the situation if the children/beneficiaries pay some or all of the premium?

A. We think this would make the children/beneficiaries settlors of the trust, and they would be deemed to be making PETs or CLTs (depending on the type of trust being used).

Or perhaps the premium payments are covered by the normal expenditure out of income exemption, or their £3,000 annual gifting allowance?

Our understanding is if the reality is that the children would be paying the parents would start the policy then assign over to the children to continue the payments on their ownership.

Q. Question re WOL, could someone set up a bond in a trust (DGT for example) and the premium is covered by the income generated?

A. Potentially, but you must remember that payments from a DGT are not “income” for the purposes of the normal expenditure out of income exemption, they are capital.

This means that premium payments for the WOL policy will be a PET (if the policy is in a bare trust) or a CLT (if the policy is in a discretionary trust) unless covered by the Annual Exemption.

Q. What are your views on a client taking income from drawdown policies to fund w/o/l premiums?

A. Nothing inherently wrong with this and can make sense for certain clients.

If the drawdown income creates a surplus for the normal expenditure out of income exemption, and that surplus is then used to fund premium payments, then that’s even better! 

Consider that you will be giving up all the growth to the protection provider if the person lives a long time investing IHT efficiently could result in a higher legacy, clearly this would need some number crunching on an individual basis.

Q. Where there are multiple beneficiaries entitled to different proportions of the estate, who do the trustees of a whole of life policy discretionary trust pay the proceeds to - the executor?

A. The trustees could pay out the funds to anyone named in the beneficiary class. So if the executor met this definition, then this would be permitted.

But rather than making an outright distribution to a beneficiary, it could be simpler for the trustees to make an interest-free loan to the executor (assuming the trust deed facilitates this). The executor could then use the money to pay the IHT, and then repay the loan once the assets in the estate have been accessed.

Q. What is the panel's experience of how quickly the insurance company pays out on a WOL policy after a death? Still waiting 7 months after a relative's death!

A. Really sorry to hear this.

This is not our area of expertise, but we think 7 months definitely seems an outlier, especially when you consider the 6-month deadline to pay IHT!

Q. Given that the (gifted) premiums for a whole life policy may not be covered by the normal expenditure out of income exemption, are there likely to be any issues funding them via a 'non-associated' annuity?

A. I assume you are referring to “back to back” arrangements. Back to back policies involved getting an annuity and WOL policy on terms that were constructed to achieve a particular tax outcome that was only available by doing transactions which were not commercially realistic.   Government legislated to stop them and HMRC confirm that the normal expenditure out of income exemption will not apply to these arrangements.

https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm20371

If you have a WOL on normal commercial terms with no account taken of the annuity and your annuity is on proper commercial terms with no account of the WOL then there should be nothing for HMRC to worry about. 

Q. re: Stuart case study. How is WOL suitable (it was labeled a MAYBE) when Stuart wants to give money away e.g. Gift Trust

A. Giving money away is going to be more effective in reducing Stuart’s IHT liability however if he wants to arrange to have the liability paid, then a WOL policy could be used to achieve this.

Q. Could you use a business whole of life plan to pay for IHT?

A. It would be best to talk to a protection provider but if you’re referring to relevant life policies we do not believe they run beyond age 75 so may not be appropriate. 

Q. If a client is a director of a Ltd company that holds a holiday home (for personal use) within the company then is this exempt from the IHT calculation? Also if he starts a whole of life policy can he pay this via his company account?

A. The client should always consult their accountant but it is likely that the holiday home would be treated as an excluded asset as it is not used for the purposes of the business. Any business relief given to the value of the shares in the limited company would be restricted to exclude the value of the holiday home.

The whole of life policy premiums could be funded from his company. Assuming that this is a personal policy, the premiums will be treated as a benefit in kind for the director and subject to income tax and Class 1 NICs. There would be no corporation tax relief for the company as this is not a trading expense.

Q. With an unquoted BR scheme my understanding is that after the 2yr qualification, you can make a gift of the holdings. These are a PET but if you die, the gift was exempt & so no IHT applies. It also means the asset is not in your estate for RNRB. This was confirmed by PUMA for their Heritage plan.

A. We definitely agree with the point about the RNRB. A gift of BR shares can restore an individual’s entitlement to the RNRB.

The other point about lifetime gifting is slightly more complicated, as the position on any failed IHT transfer (PET or CLT) will depend on whether the recipient who received the BR shares is still holding them.

So we disagree that the PET would always be exempt.

There may also be CGT to consider on the gifting of any BR shares.

Our main point on beneficiary access is if there is a requirement for beneficiaries to access for spending whilst the donor is alive then you will be in failed gift land.

Q. If you invest in BR and then gift/transfer the holdings into a trust (thereby reducing the estate for MRNRB purposes) would the IHT relief apply to the shares after 2 years, or not as they are no longer directly owned by an individual?

A. In this scenario, your client is deemed to be making a CLT. So the shares must be qualifying before placed in trust.

If they die within 7 years then whether business relief will apply to the CLT is dependent upon whether the trustees are still in ownership of the BR shares and the relief still exists.

If the trustees have disposed of the BR shares and no longer own them at the point in which the settlor dies, then the gift gets treated like a normal CLT.

Q. You keep on referring to the political/legislative risk to BR, what is to stop them changing Trust rules?

A. They could change trust rules however these changes are unlikely to be applied retrospectively. This means rule changes would have less of an impact on trusts set up other than maybe changes to periodic charge rates etc. With business relief, because the relief is only obtained on the owner’s death, any changes to the relief is more likely to have an impact on the planning.

Q. Leave it all to charity - simples!

A. Agreed. If the client wants to leave their estate to charity, IHT planning is no longer necessary and it’s just a question of advising on the clients existing arrangements and making sure they are appropriate.

Q. Penny – what’s funding the DGT

A. In the Penny case study the source of funds for the DGT was a beneficiary drawdown pot. The member died pre 75 so the drawdown pot is accessible tax free.

Q. Most examples are for clients with a lot of capital. How would this change for those with say an estate worth £8m but only £500k of that is liquid and the rest is tied up in the value of commercial / rental properties?

A. This is the type of scenario where taking out a Whole of Life policy can be particularly useful. If you don’t have capital to use towards your planning then if you can afford the premiums for WOL, you can at least arrange for the liability to be paid. Alternatively you could consider gifting properties either outright or into trust, or selling property to provide capital to plan with. These options will bring with them capital gains tax implications which need to be taken into account.

Q. Do you have anything that explains the solutions available that regain the RNRB?

A. The RNRB can be reduced or lost where the value of assets in the individual’s estate exceed the taper threshold of £2m. It is reduced by £1 for every £2 of assets in excess of the threshold so for someone who only has one RNRB available, it will be lost where assets reach £2.35m. Where a widow has inherited the unused RNRB of their deceased spouse or civil partner they will be lost when assets reach £2.7m. It’s important to remember that reliefs and exemptions are ignored when working out the value of the estate for the purposes of the taper so business relief and gifts to charity or a spouse are ignored. The way to reduce the value of the estate is to make gifts whether outright to an individual or a gift into trust. While gifts may take 7 years to fall out of the IHT calculation, for the purposes of the taper they reduce the estate value immediately. Basically, the only way to regain the RNRB is to reduce your estate.

Q. Are there any issues with payments to beneficiaries going through the settlor’s or trustee’s bank account if there is no trust bank account?

A. Ideally every trust would have a trustee bank account but in practice this doesn’t always happen. I think if you are going to use a trustee’s personal account, it needs to be very clear that the account is purely being used for administering the trust and money is moved out quickly. It would be sensible to open a separate account to make it clearer that there is no mixing of trust money with personal money.

Q. Client with 500k pension fund. If he buys an annuity with this amount does that mitigate potential IHT liability in any way?

A. Yes. If you purchased an annuity with your pension fund, your estate would immediately decrease in value. Assuming this is done in good health and not an attempt to confer a benefit on someone else the purchase in itself should not be an IHT event. Thereafter, Value Protection Lump Sums and Guarantee Periods payable on the first annuitant’s death are included in the estate.