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Loan Trust Case Study

5 min read 26 Nov 20

This is only an example of advice and isn't based on a specific client's circumstances. Your clients individual needs and circumstances will vary along with their tax situation.

Catherine and David are married and in their late 60s. They have sufficient income for day to day needs but use savings for ad hoc expenditure e.g. holidays.

They have accumulated savings of approximately £350,000 which they are confident will be sufficient to maintain their lifestyle for the rest of their lives.

They have a potential Inheritance Tax (IHT) liability which they would like to address but are not yet ready to make large gifts of capital as they want the security of having access to their savings.

Their three children are the intended beneficiaries of their estate upon second death. There are currently no grandchildren.

The adviser considers the situation and identifies these important facts about Catherine and David -

  • Sufficient income but require ad hoc access to savings.
  • Potential IHT liability needing addressed without making large gifts of capital.
  • Children will likely inherit but only after second death.

The adviser recommends the use of a discretionary Loan trust and explains it’s for those -

  • With a potential IHT liability.
  • Requiring access to original capital as necessary.
  • Looking for flexibility to waive/write off parts of the loan in due course.
  • Willing to give up access to growth on the investment.
  • Wanting to retain flexibility with regard to those who will potentially benefit in the future.

Catherine and David set up a joint discretionary Loan Trust and they are the initial trustees. Additional trustees can be appointed in the future. The trust deed contains an agreement that personally they will lend funds to the trustees (interest free and repayable on demand) so that the trustees can then apply for an Insurance Bond. They decide on an appropriate loan amount and insert that figure in the trust deed. The right to repayment of the loan belongs to them jointly while they are both alive. A trustee application for a bond is duly completed with Catherine and David funding the purchase of the Insurance Bond.

The adviser explains that neither has made a Chargeable Lifetime Transfer (CLT) for IHT purposes because they have simply loaned rather than gifted funds to the trustees. For IHT purposes, any growth arising on the bond is outside their estates from day one, since it accrues within the trust fund where the pre-printed class of discretionary beneficiaries automatically includes their children (and grandchildren) but excludes them. With growth accruing outside of their estates, the potential IHT liability on the loaned amount has been frozen.

The outstanding loan balance remains inside their IHT estates but further IHT savings will be achieved when loan repayments are taken and spent. Although they can set up a regular withdrawal facility from the bond, they decide to take ad hoc withdrawals when required. In addition, the Insurance Company offers a deed to waive the loan, or more realistically, chunks of it, if they decide that they no longer need access to the full amount. Given it is a discretionary trust, any amounts written off would give rise to a CLT, or could be exempt if they are waiving the annual exemption of £3,000 each. The amount waived will then form part of the trust fund for the beneficiaries.

They also learn that if one of them dies, the right to repayment of the loan will rest solely with the survivor. When the survivor dies, any remaining loan balance will be inside Catherine or David’s estate for IHT purposes.

Finally, the adviser draws their attention to a box in the trust deed which should be ticked if they wish the loan to be cancelled on the survivor’s death. If not ticked, then on second death the outstanding loan balance will be repaid to the deceased’s estate with the funds then distributed under the terms of the will or intestacy. If the bond has not paid out, it will need to be surrendered in full or part and chargeable event implications will arise. If the box is ticked, the outstanding loan balance is not repaid, and instead it will be distributed to potential beneficiaries of the trust. There would be no immediate necessity therefore for the bond to be surrendered. Regardless of whether the box is ticked, the outstanding loan balance will be inside the survivor’s IHT estate.

The discretionary Loan Trust provides a flexible IHT efficient solution giving Catherine and David access to the outstanding capital on demand to fund ad hoc expenditure needs.

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