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Loan Trust Guide for Advisers

Loan Trust Guide for Advisers

Loan Trust

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What is a Loan Trust?

If your client cannot give away any assets, a Loan Trust might be an option. They can create a trust with a loan which the trustees use to invest. A Loan Trust ensures any growth on the investment made by trustees will be outside their estate for Inheritance Tax purposes.

Why consider a Loan Trust?

If your client cannot give away any assets, a Loan Trust might be an option. They can create a trust with a loan which the trustees use to invest. A Loan Trust ensures any growth on the investment made by trustees will be outside their estate for Inheritance Tax purposes.

A Loan Trust allows your client full access to the original loan when needed. Loan Trusts are frequently used in Inheritance Tax planning and mitigation. Increasing numbers of people are finding that their estates may be subject to Inheritance Tax. Everyone is allowed to leave an amount up to £325,000 (the current ‘nil rate band’ fixed until the end of the 2027/28 tax year) to their beneficiaries without incurring any Inheritance Tax. Above this limit, inheritance tax is usually charged at 40%. For an estate of £750,000, for example, the tax liability could be as much as £170,000, nearly 23% of the gross estate. Generally, an investor for whom this trust arrangement would be appropriate will:

  • have a net estate exceeding £325,000;
  • not wish (or be unable) to give assets away;
  • have surplus capital to which they may need access in the future;
  • want to prevent any growth on the amount represented by the loan adding to their estate; and
  • be at least 18 years of age.

    HSBC Life’s Trust Decision Tree may be helpful in identifying suitability for your clients.

What are the benefits of a Loan Trust?

A Loan Trust allows a sum of money to be invested in an onshore investment bond, which is written in trust in order to:

  • prevent any growth on the amount represented by the loan creating a potential liability to Inheritance Tax;
  • retain access to the amount represented by the loan during your client’s lifetime; and
  • select trustees who will administer the trust and distribute any remaining trust fund to your client’s beneficiaries after their death.

What the HSBC Life Onshore Investment Bond offers

  • Direct investment into the fund – the Bond invests directly into collective investments such as open-ended investment companies (OEICs) and unit trusts, not ‘mirror funds’.
  • Flexibility – the Bond can be split into a maximum of 1,200 segments to allow tax and estate planning flexibility.
  • Transparent charging structure – all transactions are undertaken through a cash account showing charges for investment, administration and advice.
  • Individual tax calculations – we calculate the tax liability individually for each Bond, according to funds held.

How does a Loan Trust work?

To establish a Loan Trust, the person creating the trust will make an interest-free loan to the trustees. The loan is repayable on demand. The trustees direct the settlor to invest the loan monies into the bond and have the bond issued into the names of the trustees.

What is the process for
Loan Trust repayments?

What are the different types of Loan Trusts?

  • Depending on your client’s needs, they can ask the trustees to repay the loan in instalments, for example, at the rate of 5% per year. Any loan repayments should be taken and spent to maximise Inheritance Tax savings. Any outstanding loan amount will continue to be an asset of the estate for Inheritance Tax purposes, so if no repayments are taken, the original loan amount would still form part of your client’s taxable estate.

    The trust will be administered by your client’s chosen trustees who are responsible for distributing whatever is left in the trust fund after their death to the beneficiaries. The trust’s settlor will automatically be a trustee, but they must appoint at least one other trustee who can deal with the trust after their death.

    Whichever type of trust is used, the value of the outstanding loan will remain in your client’s estate for Inheritance Tax purposes.

  • A Loan Trust can be set up as an absolute or discretionary trust. When deciding which type of trust is most suitable, your client will need to consider:
    – how much flexibility they wish to have in changing the beneficiaries at a later date;
    – how much control they wish their trustees to have over the trust fund and how the chosen beneficiaries may benefit from it; and
    – how the trust will be treated for Inheritance Tax purposes.

    Whichever type of trust is used, the value of the outstanding loan will remain in your client’s estate for Inheritance Tax purposes.

What is an Absolute Loan Trust?

This trust can be used if your client knows exactly who should benefit from the trust fund after their death. When creating the trust, they must specify the beneficiary(ies) and, if more than one, the share of the trust fund to which they are each entitled.

An advantage of an absolute trust is that the Loan Trust will not be subject to Inheritance Tax – either on creation, on each tenth anniversary or when payments are made to a beneficiary. However, the trust fund does form part of the beneficiaries’ estate for IHT.

An important drawback to note when estate planning is that your client cannot change the beneficiaries once the trust is established.

What is a Discretionary Loan Trust?

A Discretionary Loan Trust gives some flexibility over who will benefit. No beneficiary will have a fixed right to anything; instead, it will be up to the trustees to decide who will benefit, in what proportion and when the trust fund will be distributed.

How does the application process work?

How will your client receive payments?

  • To create a Loan Trust, your client needs to complete the appropriate deed, either the absolute or discretionary version.

    Whichever version they choose, any growth on the Bond will fall outside their estate, thereby reducing their potential Inheritance Tax liability and will be held for the benefit of their beneficiaries.

    Whether your client is creating a Loan Trust on their own or jointly with their spouse or civil partner, they must appoint at least one additional trustee to act with them in investing the loan monies and administering the trust for the benefit of their chosen beneficiaries.

  • Your client can choose between monthly, bi-monthly (every other month), quarterly, termly (every four months), half-yearly or yearly options for their regular loan repayments, which can be commenced immediately or deferred.

    If they wish their repayments to be deferred, they should put 0% in the appropriate box on the HSBC Life draft trust deed. Once commenced, regular payments will continue until the loan has been repaid or until the value of the Bond falls to nil, if earlier.

How can your client build their Loan Trust portfolio?

A Loan Trust is a long-term arrangement, so it is essential that the widest trustee investment choice is available. With the HSBC Life Onshore Investment Bond, the trustees can access the expertise of investment managers across a range of fund management groups.

The initial investment will be allocated to the Bond and held in a cash account which forms part of the investment portfolio and is used to debit the cost of fund purchases and credit the proceeds from fund sales.

Once the trust fund is allocated to the Bond, your client and their co-trustees can then build a portfolio from a choice of collective investments such as open-ended investment collectives (OEICs) and unit trusts. Other than the minimum investment levels which apply to each asset held in their portfolio, there are no restrictions on how the investment can be spread.

The cash account can also be used to hold monies awaiting investment or as a cash shelter in times of market volatility.

Who should be a trustee?

The settlor of the trust will automatically be a trustee, but they will need to appoint at least one other trustee to act with them. Joint settlors will also need to appoint at least one additional trustee.
A trustee must be someone your client can rely on to act according to their wishes, so they should be choosen with care.
Anyone can be appointed to be a trustee provided they are over the age of 18 years and have full mental capacity. There must be at least two trustees to administer the trust. If your client wishes, they can appoint a beneficiary under the trust as trustee.
Your client may prefer to appoint a professional trustee, such as their solicitor but should bear in mind professional trustees are permitted to charge for their services.

What are absolute and discretionary beneficiaries?

Under an absolute trust, your client will name those they wish to benefit and the shares they should take. Once they have made this choice, they cannot change their mind.
In the event of your client’s death, the trustees will be able to pay the appropriate share of the trust fund to any adult beneficiaries. The trustees will usually have to retain the trust fund where there are minor beneficiaries until each beneficiary reaches age 18 (16 in Scotland).
Under a discretionary trust, the beneficiaries are described as a class of individuals such as your client’s children, grandchildren, nieces, nephews, spouse or surviving spouse (unless they created the trust as joint settlors or deliberately excluded their spouse) and the spouse or surviving spouse of any of the beneficiaries.
A discretionary beneficiary does not have an automatic right to anything under the trust – they only have the right to be considered by the trustees. The trustees can exclude a beneficiary, and your client can add to the class of beneficiaries during their lifetime.

What happens to a Loan Trust on death?

If someone associated with the trust dies, the trustees should notify us as soon as possible. We need to know if:

  • a settlor of the trust dies;
  • the beneficiary of an absolute trust dies;
  • a trustee dies; or
  • a life insured dies.

  • If the single (or surviving) settlor of a discretionary trust dies, the trustees must advise us to stop making the regular withdrawals. The trustees will then be able to either maintain the trust fund or distribute it to the beneficiaries, possibly in accordance with the settlor’s letter of wishes.

    If one settlor of a joint trust dies, the trustees will need to advise us to reduce the regular withdrawals so that only the loan repayments to the survivor continue until their share of the loan has been repaid in full.

  • If a trustee dies, the remaining trustees must notify us of this and provide evidence in the form of a copy of the Death Certificate.

    If, following the death of a trustee, only one trustee remains, the settlor or the surviving trustee should appoint a new trustee to act with them. We can provide a suitable deed for this purpose.

What happens if a life insured dies?

If one of the lives insured dies but is survived by other lives insured, there will be no effect on the arrangement, and the Bond will continue.

If the last surviving life insured dies during your client’s lifetime, the trustees must claim the Bond proceeds and reinvest these to maintain the regular repayments to your client. However, the trustees would not be under this obligation if the loan had been repaid in full.

The trustees must claim the proceeds if the last surviving life insured dies after your client’s death. If the loan has been repaid in full, whether they distribute or retain the proceeds will depend on whether the trust is absolute or discretionary and the beneficiaries’ circumstances. If any part of the loan remains outstanding, the trustees may need to repay this before taking any further action.

If, as a result of the death of the last life insured, a claim is paid under the Bond during your client’s lifetime, the trustees may need to reinvest the fund in another investment to continue making the regular loan repayments to which they are entitled.

What happens if a beneficiary dies?

If a beneficiary of an absolute trust dies, the value of the trust fund, less the value of the outstanding loan, will be included in the beneficiary’s estate for Inheritance Tax purposes. However, the heirs of that beneficiary will not be able to benefit from the trust fund until after the settlor’s death (or the survivor).

The trustees of your client’s trust could be liable to pay Inheritance Tax due to the beneficiary’s death.

What are the tax liabilities?

Rules around the way the bond is taxed in trust mean your client can arrange to receive regular payments of up to 5% of the original investment every year without any immediate income tax charge. In addition, any unused part of this unused allowance can be carried forward, so they can potentially defer any higher or additional rate income tax liability until 100% of their original investment has been withdrawn or the Bond ends.

Any amount over the 5% yearly allowance may be subject to income tax. Personal allowances on income exceeding £100,000 may also be affected.

Because we pay corporation tax on any income and capital gains realised on the underlying investments in the Bond, basic rate income tax is treated as already paid on this investment. Therefore, we calculate the underlying tax charge daily and collect a monthly tax deduction from the Bond to account for this.

The taxation of discretionary trusts

The rate for taxation of trusts will depend upon whom the liability falls.

– The settlor will be charged at their highest marginal rate

– If the settlor cannot be taxed (because they are either deceased or non-UK resident), then the UK resident trustees will be taxed at 45%, but will also receive a credit for basic rate tax of 20%

– Where a beneficiary is liable, the tax paid will depend on their personal income tax position