Over past years, many people have taken advice on putting capital sums away to improve their Inheritance Tax (IHT) situation.
There have been many different schemes on offer - some based on investments, which have favourable IHT treatment, and some based on the use of trusts.
It is the later that I will be dealing with here and, in particular, the Loan Trust using a life assurance bond, which is an excellent tool for the purpose. For those who have already set up such a plan but have not looked at it or reviewed it for some time, this may serve as a reminder on a couple of important points.
One of the benefits of the Loan Trust arrangement is that, even though the Settlor/ Lender may not need the cash payments from the start of the arrangement, it gives them the security of knowing that, at any time, they can recover any of the outstanding loan - either as a single lump sum or in instalments. Now the Settlor is, of course, the person who put the money into the plan. You should also remember that any growth in the value of the assets within the plan will accrue to the trustees rather than the Settlor.
As time progresses the Settlor may decide that he/she no longer needs access to the loan. The problem here is that the loan will form part of their estate on death and so the Settlor may be interested in giving up their rights to any outstanding loan. This being the case there are two scenarios to consider:
- Doing it during lifetime or
- On death
Dealing with each of these in turn:
1. During lifetime presents three options:
- The Settlor could demand repayment of the loan and subsequently make an outright gift of the capital. To do this the trustees would need to encash the life assurance bond. This may give rise to a chargeable gain and thus be taxable as income tax on the Settlor. The problem with this is that if the encashment proceeds of the bond are less than the value of the outstanding loan, and depending on what the loan agreement says, the trustees could be liable to cough up the difference from their own resources.
- So what if, instead, the Settlor gifted the rights? Any gift by the Settlor would need to be made by Deed to be effective for legal purposes. If this were done then the gift would be a potentially exempt transfer for IHT and, provided the Settlor lived for a further seven years, there would be no liability to IHT on that gift. This route also has the benefit of not enforcing the encashment of the bond.
- Finally, the Settlor could give up, or waive, their rights in favour of the trust. The consequences here are that the gift would be a chargeable lifetime transfer. To be effective it would need to be done by deed. Then it avoids encashment and the beneficiaries of the trust get the benefit.
2. On death
On the death of the Settlor the loan may have to be repaid by the trustees to the personal representatives. Again, if the value has fallen the trustees may have to put their hands in their pockets to make up the difference. Bearing in mind the times we are in, this may be a very pertinent point. So, to prevent this, the Settlor should do something during their lifetime. Where the loan repayments are to continue after the Settlor’s death the Settlor could bequeath the rights their spouse. The spouse’s exemption would then apply.
Either way, if you have such a plan, then a review of it would seem sensible.
Nicholas Watts is an independent financial adviser with Positive Solutions Financial Services which is regulated by the Financial Services Authority. To contact him, use the website www.realwealthmanagers.co.uk