Loan trusts on death: who gets what?

Loan trusts are a popular way of helping to mitigate Inheritance Tax while allowing the settlor to retain access to capital. How they are dealt with on death however, can cause confusion. 

How is the outstanding loan treated on death for IHT?

With a single-settlor loan trust any outstanding loan forms part of the settlor’s estate for IHT purposes. The amount in excess of the outstanding loan is not within the estate and is held for the beneficiaries of the trust.

Where the trust has been set up on a joint settlor basis the loan will normally pass by survivorship on death of the first settlor. The surviving settlor will have access to the full loan amount. Where the settlors were married or in a civil partnership the transfer of the deceased settlor’s share of the loan is covered by the inter-spouse exemption. 

How is the outstanding loan administered on death?

Assuming the loan was not waived on death, there are normally two options available to the personal representatives dealing with the settlor’s estate:

• Demand the trustees repay the loan to the estate and then distribute this in accordance with the will, or;

• Inform the trustees that an estate beneficiary is entitled to any loan repayments going forward.

What happens if the loan is “waived” on death?

The settlor can arrange for the loan to be ‘waived’ on their death. With some Loan Trust arrangements this option might have been incorporated in the loan trust paperwork. If not, this can be achieved after the trust is set up by completing an appropriate deed or including a clause in the will.

While waiving the loan does not change the IHT treatment for the settlor, it means the loan increases the trust fund of the beneficiaries of the trust rather than passing through the will.