What are loan trusts used for?
Why would you want to set up a loan trust and how does it work?
We set up loan trusts as discretionary trusts with two elements. It’s important to say that we don't use the loan trusts that are provided by large insurance companies because we want these trusts to be able to exist the full 125 years, irrespective of the viability of any given insurance company.
How is a loan trust set up?
We use our internal lawyer to set them up and we make sure that the powers of the trust are as you would expect from a normal discretionary trust. This enables us to allow the trust to continue existing in the long term if required. You make a small gift into the trust of £10 which counts as a settlement into trust and the trust is registered with HMRC. After that you can make an unlimited loan to the trustees of the trust. You could put £10 million in because the amount is not a gift to the trust, and it’s not limited as such. As it is a loan, the capital is still inside the settlor's estate. The benefit of that is it can be withdrawn at any time.
However, the main benefit is that any growth of the investment is immediately outside of the estate for inheritance tax purposes. If somebody puts £1 million in it and gets 10% growth, that 10%growth would be outside of the estate, but the original capital lent to the trust can be withdrawn back at any time.
What's a loan trust used for and how?
It's suitable for investors with large amounts of capital who have already used their full gift to trust allowance in the last 7 years.
A person, who's already gifted a full amount into a trust and is still waiting for the seven-year period to expire and doesn’t want their inheritance tax problem to get any worse, can give, for example £325,000, into a loan trust knowing that over the next seven years any growth on that investment would be outside of their estate.
After seven years, they can with draw the loan leaving the growth in the trust to continue long-term for their beneficiaries. Once the person gets their capital back, they can gift either directly to children or put it into another trust.
They may want to use the fund during the time that they're holding the loan to withdraw the money and help their children or grandchildren with education fees or purchases of properties.
This type of trust is extremely useful for managing inheritance tax problems. All growth is outside of the estate while still retaining access to the capital.
What to look out for when setting up and managing a loan trust?
We advise our clients to pull the loan money out of loan trust around the age of 75 and put it into either another trust or gift the money out directly to children depending upon what the client wants.
Single, widowed or divorced people
Another use of the loan trust is for single, widowed or divorced people who wish to make a further investment into a gift trust or flexible reversionary trust (FRT) in seven years' time.
Married couples may, for instance, put £650,000 into two flexible reversionary trusts, allowing that money to be outside of their estate after 7 years, but get the capital back in tranches, should they require it.
For single, widowed or divorced people, their limit into that type of trust is only £325,000 and they may want more capital available in later years in case they require long term care. They can make a gift to a flexible reversionary trust and they can make a loan into separate loan trust knowing that after seven years, they'll pull the money out and then either gift it or put it into another flexible reversionary trust.
The whole purpose of this is to give people the freedom to put money into a trust, understanding that any growth is outside of their estate immediately while the original capital of the investment always remains inside their estate so by the age of 75, they should be looking to dispose of that capital into other arrangements.
As always this inheritance tax planning needs experienced advice so please call us if you require help.