Estate Planning Guide

Gift and Loan Arrangement SOURCE: UTMOST WEALTH SOLUTIONS Money is loaned Individual Your Trustees LOAN Trustees invest the money in a bond the loan is fully repaid LOAN growth LOAN growth GROWTH (IHT free trust fund) loan repayments further loan repayments Beneficiaries GIFT AND LOAN ARRANGEMENTS The settlor makes a gift (generally within their available annual IHT exemptions) to establish a trust, although some providers do not have this step, however others do in order to provide certainty in dating the trust.The settlor then makes a loan to the trustees (generally interest-free) and the trustees then invest the funds loaned in an insurance or capital redemption bond. The settlor retains the right to have the loan repaid on demand and therefore the value of any outstanding loan remains within the settlor’s estate. The loan repayments can usually be set according to the settlor’s requirements, and often the tax deferred withdrawal rules are used – limiting the repayments to 5% of the initial investment per annum, before any potential income tax liability could arise. The IHT saving relates to the growth in the value of the investments held in the bond. This falls outside the settlor’s estate (assuming that no right to benefit in the trust has been reserved). This is because the growth is held for the beneficiaries and usually paid out after the settlor has died, or the loan has been repaid. The trustees are personally liable to the settlor should the trust assets be insufficient to repay the settlor. But, care needs to be taken when attempting to limit the trustees’ liability (to the assets held in the trust), which is often standard in draft loan agreements issued by many insurance companies offering these arrangements, so as not to contravene the gift with reservation rules. In fact, a 2010 case demonstrated HMRC’s attitude to this: 1. A Gift and Loan arrangement was set up and the trustees of the trust acquired an insurance bond with the funds settled into the trust. 2. When the settlor died, the value of the insurance bond was significantly less than the amount originally loaned to the trust. 3. The executors of the deceased’s estate expected that the value liable to IHT was the current value of the insurance bond on her death (no repayments had been made). 4. HMRC argued the value liable to IHT should be the value of the outstanding debt. Their argument was that the settlor had limited the trustees’ liability by the terms of the loan and caused recovery of the loan to become impossible or not reasonably practicable as she knew that the value of the “off the peg” insurance bond the trustees invested in could go down and that consequently be insufficient to repay the debt. 5. After further arguments, HMRC agreed to settle, ‘without prejudice’ at approximately half way between the value of the bond at the date of death and the face value of the outstanding debt. The settlor is generally able to write off all of the outstanding loan balance. Doing so will result in a gift of that amount at the time. However, waiving only part of a loan balance may be deemed to be a gift with reservation. Most major insurance companies offer this type of arrangement and a choice of onshore or offshore bond structures and absolute or discretionary forms of trust are generally available. The key factors to consider are the provider’s financial strength, the choice of investment funds available, the charges involved, the provider’s administrative efficiency and the availability of an appropriate form of trust. The Trust is set up with a nominal gift Immediate Post Death Interest in Possession Trust (IPDI) An IPDI allows an individual to leave the ‘life tenant’ who is usually their spouse, or civil partner, the right of occupation of their property, or the benefit of the income from their investments, without them owning the underlying capital value. As a result, the capital is protected for the individual’s intended beneficiary, known as the ‘remainderman’. A popular use of an IPDI is in second marriages where there is jointly owned property and children from a previous relationship. To ensure that their individual half share of the property passes to their respective children, mirror Wills are written for husband and wife making use of an IPDI trust. The trust is then created under the will of the first to die, and typically does not terminate until the death of the life tenant. For IHT purposes, the ‘life tenant’ is treated as if s/he owned the property, so, when they die, the assets in the IPDI are aggregated to their estate and IHT is due on the whole amount. But, the NRB can be transferred from the first to die, to offset the IHT liability on the second estate. If the ‘life tenant’ decides to terminate their life interest and the trust, it is then deemed to be a potentially exempt lifetime transfer,and provided that the life tenant lives for seven years following the termination, the capital value will fall outside of their estate for IHT purposes. 39 38 ESTATE PLANNING OPTIONS ESTATE PLANNING OPTIONS TRUST l