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The big freeze

Loan trusts have classic estate freezing qualities and can benefit IHT planners by avoiding an exit charge in the first 10 years

Over the last couple of weeks, I have been considering the role of the loan trust in estate planning. Given the publicity attaching to the discounted gift trust, the loan trust seems to have suffered at its hands. It will be seen by some as last year’s model but nothing could be further from the truth. The truth is it serves a different purpose from the DGT.

At a very simple level, the DGT works for those who want to make a gift, would like the benefit of a discounted value for the gift if they happen to die within seven years of making the gift and, most important, are happy for their retained access to be in the form of regular payments only.

The key characteristic of the loan trust is that it does not necessitate a gift but does give, as a kind of trade-off for this estate planning detriment, flexible access to an amount equal to the original capital in the form of loan repayments.

Some will see the plan as classic estate freezing, providing for the growth on the amount lent to accrue outside the lender’s taxable estate. The loan trust is thus less obviously effective from a pure estate planning standpoint but provides very flexible continuing access to funds with (hopefully) gradual accrual of benefit outside the lender’s estate.

My point over the past couple of weeks has been that even the seemingly benign loan trust, if structured on a non-bare trust basis, can give rise to a periodic charge. This risk increases if the amount lent is significant, growth is reasonably good and few, if any, loan repayments are taken.

A way of minimising the risk of an exit charge, especially for those with no history of chargeable transfers, would be to “Rysaffe” the process through the establishment of a series of loan trusts on different days, each one potentially with its own nil-rate band.

A loan trust made by a lender with a low or nil cumulative total of chargeable transfers has low to no risk of giving rise to an exit charge before the first 10-year anniversary. If the trust value at outset is nil, after deducting the loan, then regardless of the assumed transferor’s cumulative total of transfers, the tax resulting on the assu- med transfer will be nil. Consequently, there will be no need to even work out the appropriate fraction of 30 per cent of the effective rate ascertained by the necessary hypothesis. Thirty per cent of nil will be nil and the appropriate fraction of nil must always be nil.

For information, the appropriate fraction represents the total number of complete three-month periods that have elapsed from the commencement of the trust to the time of exit divided by 40. Thus, if 24 quarters had passed, the appropriate fraction would be 24/40ths or 60 per cent.

The great thing about this is that the loan trust, if it is established on a loan-only basis, provides a guaranteed nine years and 364 days window in which to make a decision as to who should benefit, regardless of the size of the loan or the extent of the growth.

So, good news for most loan trusts. Nil value at outset will mean no tax on an exit in the first 10 years, regardless of the amount exiting.

Provided the trust property has no value on a 10-year anniversary then, regardless of the transferor’s cumulative total of transfers made in the seven years preceding the establishment of the trust, there will be no charge on an exit between 10-year anniversaries, regardless of the amount of the sum assured under a life policy.

But with a loan trust – especially if there has been growth and no loan repayments – this is highly unlikely to be the case. As a result, a 10-yearly charge could arise and, as a result, an exit charge in the period following the 10-year anniversary.

Whether a charge arises will depend substantially on whether the combined value of the settled property immediately before the 10-year anniversary in question, any related property, any exits in the previous 10 years and the settlor’s cumulative total of transfers in the seven years immediately preceding the establishment of the trust exceeds the nil-rate band at the time of the periodic charge. If the combined total of all these does not exceed the nil-rate band current at the 10-year anniversary in question, then the rate at the 10-year anniversary will be nil. This means there would be no 10-year anniversary charge and, thus, no exit charge on exits between that 10-year anniversary and the next one.

If, however, the settled property does have value and, taking account of all the other amounts , the nil-rate band is exceeded, then there will be a charge at the 10-year anniversary and a basis for charging tax on exits between 10-year anniversaries. Of course, the chance of a charge arising, even where the policy has a value, will be greater when the settlor has used up part of the nil-rate band by making chargeable transfers in the seven years before the establishment of the settlement.


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