Andrew Gray, LV= Technical Manager, highlights the strategic role loan trusts can play in estate planning.
In recent years, the landscape of Inheritance Tax (IHT) planning has seen a dramatic shift. With strong investment performance, frozen tax thresholds and incremental policy changes collectively widening the IHT net, many individuals have been caught off guard. For those who may have once believed their estates to be secure, the reality may now be vastly different due to a renewed exposure to significant tax liabilities.
This evolving environment means that a reassessment of legacy planning strategies may be necessary. Among the most effective tools to consider when reevaluating these strategies are loan trusts, which are particularly valuable for individuals who have already made substantial gifts into trust within the last seven years.
Reassessing legacy planning: Bernard’s case*
Bernard, a 75-year-old widower with a long-term partner and three children. Five years ago, Bernard conducted some estate planning and implemented a Discounted Gift Trust (DGT), transferring £600,000 to benefit his family while securing a lifetime income of £25,000 for himself.
This was a tax-efficient arrangement, reducing his estate’s IHT exposure and aligning with his financial goals and providing for his loved ones.
Since then, rising asset values and frozen IHT allowances have altered Bernard’s position. This coincided with various Government announcements that have widened the IHT net and frozen IHT thresholds for the considerable future.
Therefore, despite pre-planning, his estate is once again vulnerable to a significant tax charge.
Bernard contacts his financial adviser about his concerns, who identifies several obstacles to further gifting:
- His DGT income is classified by HMRC as a return of capital, disqualifying it from the ’normal expenditure out of income’ exemption.
- Any new gifts exceeding the £3,000 annual exemption would trigger either a Potentially Exempt Transfer (PET) or a Chargeable Lifetime Transfer (CLT).
- A further CLT or PET made within the next two years would activate the ‘14-year rule’, extending the impact of his previous CLT.
- With only £25,000 of his nil-rate band remaining, any further CLT would incur an immediate 20% IHT charge on any amount exceeding this.
Next steps: The advantage of a loan trust
Bernard’s adviser explains that it would be beneficial to wait two years before making further large gifts, as this will allow the CLT made five years ago to fully drop out of his estate. To navigate these constraints, Bernard’s adviser recommends a loan trust, a structure that allows for immediate IHT mitigation without triggering the 14-year rule or incurring upfront tax charges.
A loan trust involves setting up a trust and then making a loan to the trustees, which is interest free and repayable on demand. The loan is then invested, usually within a life assurance investment bond. The loan will remain in Bernard’s estate for IHT purposes but any growth accruing on the investment will be outside his estate and will be for the trust’s beneficiaries. This approach offers several strategic benefits:
- Bernard retains access to the loaned capital and can control how the trust benefits his partner and descendants.
- Future investment growth in the trust escapes IHT from inception.
- Unlike the DGT, the loan trust does not generate income and repayments are made only if needed.
- Bernard can start writing off the loan using his annual gift exemption and, in two years, consider larger gifts without reactivating the earlier CLT.
Broader implications for advisers and their clients
Loan trusts are being increasingly re-visited as a versatile solution in current estate planning. They are particularly valuable for clients who have previously used trusts and made CLTs in the last seven years, as they offer a way to pause, reassess and re-engage with gifting strategies without immediate tax consequences.
Investment bonds are particularly suited as trustee investments. They allow 5% tax deferred withdrawals, do not produce income and are not subject to Capital Gains Tax (CGT).
Bonds have become more relevant for most trusts following changes to CGT and freezes in income tax bands. Trustees now only have a CGT allowance of £1,500, meaning that even simple rebalancing via a Managed Portfolio Service (MPS), can now result in trustees incurring a CGT charge when investing through a General Investment Account (GIA).
To conclude
As the IHT environment evolves to become more complex, not least because of the government’s stated plans to bring unused pension funds into scope for IHT, advisers must adopt a dynamic, forward-looking approach. Loan trusts can offer a strategic bridge, allowing clients to manage their IHT exposure today while also preserving flexibility for tomorrow. For people like Bernard, they represent not just a financial tool, but a pathway to secure legacy planning in an uncertain fiscal future.
*For illustrative purposes only
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