How to pass on wealth AND keep control of it: Super-rich families use this technique to
If you’re trying to reduce a potential inheritance tax bill, the most common solutions typically involve spending the money yourself or gifting it during your lifetime so that it is not taxed on your death.
However, it’s sometimes hard to hand over your hard-earned wealth to loved ones and watch them do with it as they choose.
What if they spend it recklessly, for example, or if it turns out you need the money for yourself.
There is a solution that starts to get your money out of your estate for inheritance tax (IHT) purposes, but still lets you retain control over it.
It’s called a loan trust, and has long been a favourite financial tool among wealthy families. It is not the easiest way to mitigate against IHT, and requires expert help to set up, but for a growing number of families it is a neat move.
And more families than ever are now paying IHT – a record £315million in 2023-24 tax year. If your assets are worth more than £325,000 when you die (£500,000 if your main residence passes to your children or grandchildren), then the excess is subject to IHT at 40 per cent.
What is a loan trust?
A trust is simply a legal arrangement where you hand over money or assets to be held and managed by appointed people – called trustees – on behalf of others, who are known as beneficiaries.
You may, for example, name yourself, trusted friends or family members, or professionals such as solicitors, as trustees, and name your children or grandchildren as beneficiaries.
Ruth Jackson-Kirby says there is a solution that starts to get your money out of your estate for inheritance tax (IHT) purposes, but still lets you retain control over it
A loan trust is different from gifting money to family, which can attract taxes if you die soon after… as you are effectively lending money to the trust as an interest-free loan.
With a standard trust, money put into a trust is considered a gift to the beneficiaries, which is managed by the trustees. As soon as you’ve made the gift, the IHT seven-year rule comes into play.
If you survive seven years after giving away the money, it falls outside your estate, and no inheritance tax is due on it.
Die within those seven years and it will still be counted as part of your estate and taxed accordingly.
A loan trust is different, as you don’t gift your money away. Instead, you lend it to the trust as an interest-free loan.
It is invested by the trustees, and any returns – from investment growth, dividends or interest – belongs to the beneficiaries and is not generally counted as part of your estate for IHT purposes. The capital remains yours.
The advantage of this is that you can recall the loan at any time.
You could set it up so you get regular loan repayments or simply take back the money if you need it.
So if you want to do some IHT planning, but are worried you might need money in later life, a loan trust could help.
‘Think of it as putting money into a separate family pot with an IOU attached,’ says Josh Croft, senior technical consultant at investment specialists AJ Bell.
‘You can reclaim the amount on the IOU, but any growth in the pot is kept for the beneficiaries.’
Take, for example, Robert and Diane – a couple in their 70s who place £100,000 into a loan trust for their children. The trustees invest it and it returns 5 per cent a year. After five years there is £127,630 in the trust. Of that, £100,000 still belongs to Robert and Diane – but the £27,630 of growth belongs to their children, free of IHT.
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So I will still be able to access all of my money?
You can take back some or all the initial amount you loaned to the trust whenever you like, but you have no claim on the growth – that belongs to the beneficiaries.
Alternatively, you can waive your right to it, at which point it belongs entirely to the beneficiaries.
You could hand it over all at once, in which case if you die within seven years it may still count as part of your estate for IHT purposes. Or you could waive smaller chunks to take advantage of your gifting allowances.
You can gift up to £3,000 each year and it is immediately free of IHT.
In our scenario, Robert and Diane could waive £6,000 a year using their combined allowance, and that money would be immediately out of their estate for IHT purposes.
‘Many people choose to write off loans gradually over a number of years, allowing them to balance inheritance tax planning with the reassurance of maintaining financial security,’ says Helen Morrissey, head of retirement analysis at investment platform Hargreaves Lansdown.
‘This approach can be especially valuable for those who are cautious about making large, irrevocable gifts from the outset.’
What pitfalls should I watch out for?
You can set up a loan trust either as an absolute or discretionary trust – it is important to understand the difference.
With an absolute trust, beneficiaries can take their money once they turn 18.
A discretionary trust instead gives trustees the power to decide when they benefit – so choose your trustees carefully and give them a letter of wishes setting out what you want to happen.
It is also worth deciding upfront what happens to the loan when you die.
You can write into the trust documents that it should be automatically waived on your death, which means the money passes straight to the trust’s beneficiaries.
If you don’t, the outstanding loan falls back into your general estate and is distributed according to your will – which may mean it ends up with people other than the trust beneficiaries.
Either way, if your estate exceeds £325,000 – the so-called nil-rate band – then the money is liable for IHT at 40 per cent.
‘Loan trusts can seem complex, and it is always important to seek tax and legal advice,’ says Daniel Hough, a director and wealth manager at RBC Brewin Dolphin, ‘but when implemented properly they can be a relatively straightforward solution that delivers meaningful benefits.’
Are you worried that inheritance tax will affect your family? Email: money@mailonsunday.co.uk
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