You want to reduce your inheritance tax exposure but you’re not prepared to give away your capital just yet. How can using a trust to purchase an investment bond help you do both?
IHT planning
Reducing or avoiding inheritance tax (IHT) directly or indirectly involves giving away your assets. The usual advice is to give away as much as you can as soon as you can because until seven years elapse from making the gift it remains part of your estate for IHT purposes. Normally, once you make a gift the money or other asset you gave away is gone for good. This means you’re stymied if you need access to the capital later.
Trap. All the time that you retain any rights over the asset you gave away HMRC’s anti-avoidance rules mean that, once again, it remains part of your estate for IHT purposes.
It’s a matter of trust
One IHT planning trick is to make your gifts into a trust where the people you want receive the money or other assets are the beneficiaries. If this is done through a so-called loan trust, you can retain access to the capital while giving away the income from it in an IHT-efficient way. The good news is that you don’t need to lay out a fortune in legal fees to set up this type of trust.
Tip. Many insurance companies have off-the-shelf loan trust schemes. Even so, you should speak to a financial advisor before committing.
Trust details
Usually, a loan trust involves an investment bond and a reversionary clause in the trust. The bond can be one you already own which you transfer to a trust, or you can make a cash gift to the trust which then purchases a bond. All the admin for this is handled by the insurance company. You can find insurance and investment companies that offer loan trusts by searching online.
Trap. For the trust to be effective for IHT saving you must tie your money into it for at least seven years, preferably more.
Tip. Gifts to a reversionary loan trust are most tax efficient if they do not exceed the IHT nil rate band (NRB), currently £325,000. Above this IHT is payable at 20% on the excess. However, depending on whether you have made other IHT chargeable gifts, you can create further reversionary trusts every seven years. This means that you can make more IHT-efficient gifts up to the value of the NRB each time.
How does the loan trust work?
The insurance company invests your money into a series of bonds worth, say, £2,000 each. These are held by the trust which the insurance company administers. The bonds pay out at different times that are scheduled at the outset of the scheme. When each bond matures you have the option of taking the money. Alternatively, the money can be rolled back into the trust for your beneficiaries.
Tip. If you want your beneficiaries to have access to capital sooner than seven years, you can ask the insurance company to include a clause in the trust that allows the trust to make interest-free loans to them as an advance against the capital which will become available when each investment bond matures.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.