Reducing IHT with a simple trust arrangement

IHT planning

Reducing or avoiding inheritance tax (IHT) directly or indirectly involves giving away assets. The usual advice is to give away as possible as soon as possible because until seven years elapse from making the gift it remains part of the estate for IHT purposes. Normally, once a gift is made the money or other asset given away is gone for good. This means the individual stymied if they need access to the capital later.

If the individual retains any rights in the asset it remains part of their estate for IHT purposes under the reservation of benefit rules. As a result, the individual couldn't reduce their taxable estate by, say, gifting their home to their children and continue living in it without paying a market rent.

It’s a matter of trust

One IHT planning trick is to make gifts into a trust where the people to receive the money or other assets are the beneficiaries. If this is done through a so-called loan trust, the individual can retain access to the capital while giving away the income from it in an IHT-efficient way. The good news is that they don’t need to lay out a fortune in legal fees to set up this type of trust.

Many insurance companies have off-the-shelf loan trust schemes. Even so, anyone considering this should speak to a financial advisor before committing.

Trust details

Usually, a loan trust involves an investment bond and a reversionary clause in the trust. The bond can be one the individual already owns which they transfer to a trust, or they can make a cash gift to the trust which then purchases a bond. All the admin for this is handled by the insurance company. They can find insurance and investment companies that offer loan trusts by searching online.

For the trust to be effective for the IHT saving they must tie their money into it for at least seven years, preferably more.

Gifts to a reversionary loan trust are most tax efficient if they do not exceed the IHT nil rate band (NRB), currently £325,000. Above this IHT is payable at 20% on the excess. However, depending on whether the individual has made other IHT chargeable gifts, they can create further reversionary trusts every seven years. This means that they can make more IHT-efficient gifts up to the value of the NRB each time.

How does the loan trust work?

The insurance company invests the money into a series of bonds worth, say, £2,000 each. These are held by the trust which the insurance company administers. The bonds pay out at different times that are scheduled at the outset of the scheme. When each bond matures the holder has the option of taking the money. Alternatively, the money can be rolled back into the trust for their beneficiaries.

If the holder wants their beneficiaries to have access to capital sooner than seven years, they can ask the insurance company to include a clause in the trust that allows the trust to make interest-free loans to them as an advance against the capital which will become available when each investment bond matures.