Loans from Trust: With case studies
17 February 2021
Using case studies, John Humphreys, Inheritance Tax Specialist, WAY Investment Services, looks at where loans from Trust have been used to help family members achieve their financial goals
It is entirely natural for parents to wish to help and support their children. It is also entirely normal for parents to have some reservations about doing so, not least when it comes to financial matters. Concerns may be regarding a choice of partner, or the risks the next generation might be taking in a new business adventure. For themselves, a common theme that advisers report hearing is worry about being able to cover unknown care costs at some unspecified time in the future.
One strategy that can be employed to address both those concerns and the wish to help family is the use of Flexible Reversionary Interest Trusts with loan facilities. The Trust is set up so that the Trustees can, at their discretion, advance money to Beneficiaries by way of a Loan or an Appointment of capital. A particular advantage with a loan is that it remains a debt of the recipient and an asset of the Trust, and in this way can be used to protect ‘family wealth’. Before receiving the loan, the Beneficiaries sign a formal Loan Agreement. Should the recipients divorce, be declared bankrupt, or face their own inheritance tax (IHT) liabilities, the outstanding loan reduces the value of their assets. Though a popular method for gifting, it is worth bearing in mind that Discounted Gift Trusts cannot offer such loan facilities during the Settlor’s lifetime. This is because the Trustees are under obligation to provide reversions to the Settlor based on the original discount (typically 5% per annum tax-deferred withdrawal from an investment bond), and if the value of the remaining investment falls, they may become unable to do so.
Over the last 16 years I have seen the Trustees of Flexible Reversionary Interest Trusts use loans from Trusts to help family members through a variety of circumstances and situations which they have faced. As part of a long-term financial strategy, many of those Trusts continue to be in place today – supporting and ready to support family members intergenerationally (up to the perpetuity period of 125 years). Let’s consider some real-life examples where families have used loans from Trust to help everyone achieve their financial goals.
Back in 2003, a married couple each set up a Flexible Reversionary Interest Trust with their adult children as named beneficiaries. A year later, their son was promoted at work, but the promotion involved a relocation to a different part of the UK. He and his wife found a home they liked in the new area, but before they were able to sell their existing home. They could not afford to maintain two mortgages, and with a young child to look after, the prospect of a bridging loan looked unduly stressful.
The family’s financial adviser discussed the situation with them and approached the Trustees about a potential loan. The Trustees agreed to loan 50% of the purchase price of the new home from each of the parent’s Flexible Reversionary Interest Trusts, so the young family were able to purchase the new house with no mortgage. The son and daughter-in-law both signed a formal Loan Agreement with the Trustees, and the money was advanced to them. A point of reassurance to the parents was that in the unfortunate event of divorce, the Trustees would have the discretion to recall the loan and thereby protect the ‘family wealth’. As it happened, it was just a few months later that the young family sold their previous home. The Loan was repaid to the Trust in full and the money reinvested, where it could hopefully grow for the future benefit of the Settlor (if reversions were ever required), or the Beneficiaries where the money could be loaned (again) or appointed, as appropriate.
In 2009, a mother set up a Flexible Reversionary Interest Trust with a gift of £178,000 with her adult children as named Beneficiaries. Four years later, her son was looking to buy a house. The Trust had seen some growth and the Trustees were able to agree to a loan of £180,000. A further four years on, the son was able to repay the loan in full and the Trustees reinvested the funds. It is also worth bearing in mind that by this point, a full seven years had passed since the Trust was set up, so the gift was outside the mother’s estate for IHT purposes. In 2018 the son approached the Trustees again as he wished to buy a property abroad, and they advanced a loan of £70,000. Crucially, at each stage the family’s financial adviser consulted with all of the main Beneficiaries before the loans were granted, in order to ensure that everyone was comfortable with what was being proposed. In September 2019, the Trust was valued at £244,000. This included the outstanding loan of £70,000, so £174,000 remained invested for the benefit of the Beneficiaries and reversions to the Settlor, should they ever be required.
Loans to spouse/partner
A third scenario worth considering is the use of loans from Trust to support spouses or civil partners. A spouse or civil partner cannot be a named Beneficiary of a Flexible Reversionary Interest Trust during the Settlor’s lifetime, as HMRC deem spouses or civil partners to be an ‘associated operation’ for Gifts with Reservation of Benefit purposes, but they can be appointed as an Appointed Class Beneficiary on the Settlor’s passing. On the death of a spouse or civil partner, loans from Trust could be advanced to a surviving spouse or civil partner to offset any fall in income, offering considerable flexibility and access to funds. If the loans were spent to support ongoing living costs, the debt would be attached to the survivor’s estate, reducing the net estate value for probate and IHT purposes. On the second death, after probate is resolved, the loan could be repaid to the Trust which could go on to make future loans to children or other Beneficiaries, as such Trusts have a 125-year perpetuity period.
Loans from Trust have the potential to enable many families to provide support to loved ones in a controlled and measured manner. An understanding of how they work and the options available should certainly be part of the knowledge base for planning teams.
This article was first published in the February 2021 issue of Professional Paraplanner.