Loan Trusts

A Loan Trust normally has to be set up with new monies, as you cannot normally use an existing bond to create a Loan Trust. The settlor lends monies to the trustees who in turn buy the bond.

The trust has to be created first, the settlor then lends money to the trustees who then buy the bond. It is generally acceptable to have the date of the trust and the date on the application form dated on the same day, as the assumption is the trust was dated earlier in the day, before the application.

It is not acceptable to have the bond dated before the trust deed as you cannot set up a bond with trustees who do not exist yet.

You can generally top up an existing Loan Trust and the settlor can do this by either way of a further loan or by way of a gift.

The settlor has full access to any outstanding loan, but not the growth. The loan is interest free and repayable on demand. In a joint settlor case the right to repayment of the loan will automatically pass to the survivor. All of the growth and any amounts subsequently waived is for the benefit of the beneficiaries and therefore the settlors have no access to the trust fund whatsoever.

In respect of the beneficiaries this depends on whether it is an Absolute trust or a Discretionary trust that has been chosen.

Under an Absolute trust, the beneficiaries can demand the trust fund once they reach age 18 (16 if written under Scottish law) and the trustees are legally obliged to inform the beneficiary that the trust fund exists. The trust fund will form part of the beneficiary’s estate for IHT purposes. If an absolute beneficiary dies the trustees have to look at the will or follow intestacy rules to see who will then benefit.

Under a Discretionary trust it’s up to the trustees to decide who will benefit and when they will benefit from the trust fund. If the beneficiary is in the class of beneficiaries, the trustees can allocate funds to them.

It is wise for clients to lodge a letter of wishes with the trustees to give them some guidance, after their death, as to how they want the trust fund divided up. Remember that a discretionary beneficiary cannot demand monies from the trustees nor does this form part of their estate for IHT purposes while inside the trust.

There is no entitlement to the outstanding loan by the beneficiaries.

If the bond falls in value the settlor's loan cannot be fully repaid. Whether the trustees are liable for the shortfall depends on the terms of the trust and the circumstances of each case.

There is no transfer of value when you set up a Loan Trust, as it is not a gift, just a loan. Any amounts waived which are not exempt will either be a potentially exempt transfer (PET) or a chargeable lifetime transfer (CLT) depending on whether an Absolute trust or a Discretionary trust has been chosen.

Under an Absolute trust, the amount waived (if not exempt) creates a PET which after seven years from the date of the deed of waiver becomes exempt from IHT. If the settlor dies within the seven years, the PET becomes chargeable.

Under a Discretionary trust, the amount waived creates a CLT which may (rarely) attract an entry charge if the value of the waived amount when added to any other CLT’s made in the previous 7 years exceeds the settlor’s current nil rate band. CLT’s drop out after seven years as long as no PETs are created after the CLT. If a settlor creates a mixture of PETs and CLTs this can lead to a 14-year timeline. If a PET fails and becomes chargeable, it pulls in any CLTs made within 7 years of the failed PET thus potentially going back 14 years. The order of gifting is important (see our guide on the sequence of gifting).

Discretionary trusts may also be subject to periodic charges every 10 years and exit charges. In the case of a loan trust the assessable amount would be the bond value, less the outstanding loan.

The 10-year anniversary charge must be reported to HMRC unless the ‘excepted settlement’ rules apply. These rules state that reporting is not required where the ‘value’ (of the bond) does not exceed 80% of the nil rate band.

Gifts, either PETs and CLTs offset the nil rate band in chronological order thus when calculating any IHT liability they will be applied first against the nil rate band.

Any outstanding loan forms part of the settlor’s estate for IHT purposes.