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Have a gift trust in your armoury

For this week&#39s article, I would like to pick up on the theme covered by Colin Jelley in this column on August 7 concerning inheritance tax planning for clients following the Inland Revenue&#39s announcement on June 20 which heralded the demise of planning using the so-called spousal interest trust route.

Colin highlighted the benefits of planning using a discounted gift trust, the underlying product for which would be a capital redemption policy, and there is no doubt that this type of product is a very powerful weapon in the adviser&#39s armoury, providing as it does the opportunity for an immediate IHT saving should the client fail to survive the gift by seven years.

However, when discussing IHT mitigation with clients, it is important to remember that every client is different and that a discounted gift trust will not be ideal in every situation, particularly where the client wants to retain the possibility of accessing capital at some time in the future.

So what remains for such a client, someone with capital available but who may want to access that capital at some future stage and will certainly require an income from it?

In these circumstances, there is still a place for the old IHT planning technique of utilising a gift and loan scheme or perhaps, better still, a loan-only plan.

Under a gift and loan plan, the client sets up a trust for a small amount and then lends the trustees a significant sum. The trustees use this loan to buy a single-premium bond and take withdrawals from it (usually within the 5 per cent tax-deferred entitlements) as part repayments of the loan.

On the client&#39s death, any outstanding amount of the loan remains part of his estate but all the growth on the bond is outside his estate from day one.

The loan is documented as interest-free and repayable on demand and thus the client can access the outstanding amount of the loan at any time should his circumstances change by simply requesting that the trustees immediately repay him the outstanding balance.

Thus the client&#39s desire to be able to access his capital is satisfied and the regular loan repayments by the trustees will provide him with his “income”.

Provided that this “income” is spent each year as it is received, the client&#39s estate will gradually decrease. The longer he lives, the smaller will be the amount of the outstanding loan which will still form part of his estate. Further flexibility can be provided by the fact that the loan repayments do not have to be of the same amount each year but can be varied by the trustees if necessary.

The same objective can be obtained without the initial gift by using a loan-only scheme. In this type of arrangement, the trust property consists solely of the intention to make an interest-free loan. There is no need for the initial gift, thereby making this type of planning simpler and involving less form filling.

One danger with this type of planning that advisers must avoid is that, if dealing with married couples, it should never be recommended that each creates a trust under which the other can potentially benefit, that is, a husband sets up a trust under which the default beneficiaries are his children, with his wife as a potential beneficiary and his wife does the same thing but under her trust, her husband is a potential beneficiary.

In these circumstances, the Inland Revenue will say that a gift with reservation by way of a reciprocal arrangement has been created and thus both arrangements will be ineffective for IHT purposes.

In situations involving married couples, it is therefore preferable for just one of the couple to create the trust, include the spouse as a potential beneficiary and include a clause in the settlor&#39s will so that on the death of the settlor, his right to the outstanding loan repayments will pass to the spouse.

It can thus be seen that both the discounted gift trust and the loan trust have their place in the IHT planning arena, the principle advantage of the discounted gift trust being the immediate reduction in the settlor&#39s estate, whereas the loan trust provides the opportunity for access to capital but the price for this is that the IHT benefits take much longer to build up. For IHT planning, as for anything else in life, it is very much a case of horses for courses.


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