Remember: the arrangements covered should not be entered into without first consulting with a suitably qualified and experienced adviser.
A refinement of the Nil Rate Band (NRB) Discretionary Trust, loan trusts do exactly what it says on the tin, namely money is ‘lent’ to a trust and in return tax-free repayments are received. The capital ‘lent’ remains within the settlor’s estate for IHT purposes, but any capital growth is kept outside.
• Individuals who wish to reduce the future growth of their estate, not adding to the IHT liability but who do not wish to gift the capital as yet.
• Individuals who have surplus capital which is not currently needed but which might be needed in the future.
• Individuals who wish to have a regular income.
How does it work?
• A ‘Mainstream’ Loan Trust is created with a small gift into the trust (say up to the annual gift allowance of £3,000).
• An interest-free loan of the capital amount is then made to the trust - repayable on demand. Being a loan rather than an outright gift there will be no potential IHT charge. Unfortunately, the loan can only be of cash and not of any other assets because the capital is invested into an insurance bond written in trust for chosen beneficiaries.
• The trust then repays the loan in payments of up to 5% of the amount invested in the bond for each year thereby ensuring that there will be no chargeable event for income tax. The allowance is cumulative such that if 5% is not taken in year one, 10% can be taken in year two, etc, for up to 20 years.
Discounted Gift Trusts (DGT)
DGTs are another variation of the NRB discretionary trust such that the capital/cash investment is deemed to be a gift again invested into an insurance bond for chosen beneficiaries with a fixed amount of income drawdown. This time the trust allows the settlor to retain income from a portion of the capital and to gift the remaining portion, the latter portion becoming free of IHT after seven years as it is a gift. Keep the gift to below the NRB and there will be no tax charge on the transfer into the trust.
Situations where the estate needs to be reduced immediately to below the IHT limit but a regular income is required.
How does it work?
• A ‘Mainstream’ trust is created with a lump sum.
• The amount of income stream needed is calculated.
• The gift is a ‘loss to the estate’, actuarially calculated as the initial gift less expected payments.
Which is best?
The two trust arrangements are not mutually exclusive and are often used in tandem. The comparison uses can include:
• The loan trust is the more flexible in allowing a change of beneficiaries and an ability to vary or suspend income payments and to reclaim the capital. The DGT does not allow the income amount to be varied or suspended or not taken from the outset, nor allow access to larger sums. Furthermore, the beneficiaries cannot be changed.
• The DGT moves a potentially significant proportion of the trust assets outside of the estate immediately and the balance, on survival, after seven years. The loan trust, by comparison, takes longer to move significant sums outside of the estate.
• The DGT income provides income withdrawals for life. By contrast, the entitlement under the loan trust available to the donor is capped at the sum originally loaned to the trust. Once the loan is fully repaid the donor has no additional entitlement.
• Should income not be needed but it is desirable to have the option to access income or capital in the event of unforeseen circumstances, this will favour the loan trust route (assuming that the settlor has a fairly long life expectancy). In comparison, the DGT will remain paying the fixed withdrawal amount established at the outset back into the estate for each year. If the settlor lives for twenty years or more, the loan trust is likely to be the more effective for IHT purposes, especially where the settlor does not draw income or capital from the trust.
The ’Charge’ route is a yet another variation of the ’loan’ scheme by which the trustees are given the power to accept a charge in satisfaction of the legacy secured on the assets contained in the residue of the estate - which could, this time, include the deceased’s share in a property. There is no cash involved, nor purchase of any bonds.
The surviving spouse will normally have no personal liability for the charge, which can be index-linked to take into account future increases in the NRB. Alternatively, the charge can be expressed as a proportion of the value of the house calculated periodically thereby benefiting from any capital appreciation, or it could be made to track a publicly available index of house prices for comparable properties. Once again, on the death of the surviving spouse IHT will be payable but reduced by the charge and if calculated correctly, to below the NRB.
Advantages and disadvantages:
• The surviving spouse is able to continue in occupation of the house as it has been left to him/her absolutely.
• As the house remains owned by the surviving spouse, it can benefit from either capital gains tax principal private residence relief should the house be subsequently sold, or a base cost uplift if retained until death.
• When the remaining spouse dies the debt owed to the NRB Trust will reduce the size of their estate.
• The main disadvantage is that Stamp Duty Land Tax (SDLT) may be payable on the value of the half share of the property given above the SDLT limit. This is because the property is effectively being sold to the surviving spouse in exchange for that part of the IOU which reflects the half share value of the house.
The choice of trust, or indeed combination of trusts, is usually influenced by age, income requirements and the need for access to capital. Broadly speaking, the older the life and greater the need for income the DGT is normally more appropriate. Conversely, the younger the life, where more importance is placed on access to capital and without any specific income requirement, the greater the attraction of a loan trust. Finally, it should be remembered that where the priority is to remove the asset from the estate relatively quickly, a business property relief investment is likely to be the most effective solution.
By Jennifer Adams