LOAN TRUST (CREATING FIXED TRUST INTERESTS) ESTATE PLANNING WITH THE LOAN TRUST

Transcription

1 LOAN TRUST (CREATING FIXED TRUST INTERESTS) ESTATE PLANNING WITH THE LOAN TRUST

2 THE LOAN TRUST MAY BE SUITABLE FOR YOU IF: Your estate will be liable to inheritance tax on death, even if maximum use is made of exemptions, reliefs and the nil rate band. You are unable or unwilling to make outright gifts as you require (or may in the future require) access to your original capital on either a regular or ad hoc basis. You have a lump sum available for investment. You are willing to forego access to any future growth on the amount invested. You are willing to make a decision now on who should benefit from any future growth on the amount invested and accept that you will not be able to change your decision at a later date.

3 PAGE 2 INTRODUCTION PAGE 3 THE LOAN TRUST HOW THE LOAN TRUST WORKS THE POSITION ON DEATH THE TRUSTEES RESPONSIBILITIES UNDER THE LOAN TRUST PAGE 6 SUMMARY SUMMARY OF BENEFITS SUMMARY OF RISKS PAGE 7 TECHNICAL QUESTIONS AND ANSWERS SETTING UP THE TRUST TRUST ISSUES THE LOAN INHERITANCE TAX 1

4 INTRODUCTION With the nil rate band frozen at 325,000 for tax years up to and including , clients will be looking for ways to protect their assets from potential liability to inheritance tax in future years. It is possible to reduce an inheritance tax liability by making lifetime gifts of capital that reduce the overall value of your taxable estate. However, substantial outright gifts will not always be possible or desirable, as this will usually mean giving up access to income or capital or both. Access to capital may be required to supplement income or simply to provide a safety net in case of changing circumstances. The Loan Trust can be an effective solution enabling you to achieve inheritance tax savings over time whilst allowing for continued access to your original capital. 2

5 THE LOAN TRUST HOW THE LOAN TRUST WORKS The first step is to set up a Loan Trust for your chosen beneficiary or beneficiaries (excluding yourself and your spouse/civil partner). As the person who establishes the trust, you are the settlor. You make a loan to the trustees, which the trustees invest (usually into a bond). The loan is interest free but is repayable on demand under a binding legal obligation. You thus retain access to your capital. Joint settlors Where the Loan Trust is created by joint settlors who are legally married or are in a registered civil partnership with each other, each of you will be treated as having made a loan equivalent in value to one-half of the total loan amount. In other circumstances, you will need to have evidence that the amounts each settlor contributed were equivalent in value to one-half of the total loan amount. Any growth on the investment is held outside your estate for the trust beneficiaries, whilst the outstanding loan will remain as an asset of your estate and so potentially subject to inheritance tax on your death. As you are excluded from benefiting from the investment growth, you have effectively frozen the inheritance tax liability on your investment at its current value. Settlor Step 1 You set up a Loan Trust appointing yourself and one or more others as trustees and you lend the investment amount to the trustees Step 2 The trustees invest the loan in a bond Step 3 Original capital loan repayable to you on demand Growth held outside the estate freezing the tax liability on the amount invested 3

6 The Loan Trust is most efficient where the loan is repaid in regular instalments and spent by you as income but it may also be appropriate where income is not required. The arrangement is therefore suited to a wide range of clients and circumstances. Any adult beneficiary may call for the trust fund, or their share of the trust fund, to be paid over to them at any time. In these circumstances, the trustees will first repay any outstanding loan to you. Providing you with income The potential for inheritance tax on the outstanding loan can be reduced where the loan is repaid to you in instalments and spent by you as income. Provided that the loan repayments are not accumulated elsewhere in the estate, the taxable asset (the loan) will gradually reduce in value, as will the resultant inheritance tax liability on your estate. The trustees will usually fund regular loan repayments by taking regular withdrawals from the bond. There will be no immediate liability to income tax provided the amounts withdrawn in any year do not exceed the accumulated tax-deferred 5% allowance (and a maximum of the amount invested). Example Mr T, age 70, establishes a Loan Trust with a loan of 200,000. The trustees repay the loan in annual instalments of 10,000, which Mr T uses to supplement his pension income. No immediate liability to income tax arises as the amounts withdrawn from the bond are within the 5% allowable limit. However, there may be an income tax liability when a chargeable event occurs. In the event of Mr T s death, age 89, only 10,000 of the original investment remains in his taxable estate. Mr T has had the benefit of a tax-efficient income for life and any investment growth is held outside his estate and is available to the trust beneficiaries. Where income is not required Loan repayments can be taken in regular instalments as described earlier or on an ad hoc basis as and when capital is required. The Loan Trust may thus also appeal to those who do not need income currently but are unsure whether this will continue to be the case in future. Repayment of part, or all, of the loan can be waived in favour of the trust beneficiaries at a later date if circumstances make this appropriate. Example Mrs E, a widow age 60, establishes a Loan Trust with a loan of 100,000, which the trustees invest in an investment bond. No income is taken for the first five years to the effect that the asset (the loan) is simply frozen at its original value for inheritance tax purposes. After five years, Mrs E s circumstances have changed and she is feeling more confident about her financial position. She therefore decides to waive repayment of half of the outstanding loan in favour of the trust beneficiaries. Provided the waiver is made by deed, Mrs E will be treated as having made a potentially exempt transfer for inheritance tax purposes but no money leaves either the bond or the trust. It may alternatively (or additionally) be possible to make gifts of regular loan repayments not required as income. However, there may be inheritance tax consequences if the amounts gifted exceed 3,000 in any tax year or if the inheritance tax annual exemption has already been used in the relevant tax year. 4

7 THE POSITION ON DEATH The balance outstanding on your loan at any given time is an asset of your estate and will be potentially subject to inheritance tax on your death. In addition, if no other arrangements are made, the benefit of any outstanding loan will pass as part of your estate on your death either under your will or under the intestacy rules if no will has been made. By making specific provision in your will, it is possible to ensure that any loan balance outstanding at the time of your death passes as an addition to the trust fund rather than to the beneficiaries of your estate. Amending your will to leave any outstanding loan to the beneficiaries of the Loan Trust may also have income tax advantages if the bond has been written so that it will not automatically cease on your death. Your executors will not then usually need to call in the loan unless there are insufficient assets in your estate to satisfy your debts and other liabilities. This ensures that the point at which any gains under the bond become chargeable can be controlled. A draft codicil for consideration by your solicitor is available on request should you wish to consider adapting your existing will to waive any outstanding loan in favour of the trust beneficiaries on your death. Detailed information on the inheritance tax implications of waiving the loan in favour of the trust beneficiaries can be found in the technical questions and answers section of this brochure. Note that it is alternatively possible to leave the right to outstanding loan repayments to a surviving spouse or civil partner. A draft codicil wording that allows for this is available on request. In the case of joint settlors, on first death the amount of outstanding loan owing to the deceased will pass according to the terms of his or her will. Joint settlors should therefore strongly consider updating wills in this way to avoid the trustees having to encash the bond and repay a proportion of the proceeds to the estate of the first to die. THE TRUSTEES RESPONSIBILITIES UNDER THE LOAN TRUST You and the additional trustees hold the trust fund as nominees for the beneficiaries. The trustees should also keep a record of the loan repayments made to the settlor, not least because payments to the settlor must cease once the loan has been wholly repaid. This is vitally important, because if the total amount repaid to the settlor exceeds the loan amount: the trustees would be in breach of the terms of the trust and may be personally liable for the cost of restoring the trust fund to the position it should be in; this cost may be greater than the amount overpaid alternatively, the settlor or the settlor s estate may be treated as holding the overpaid amounts on trust for the beneficiaries of the Loan Trust if the settlor retains or spends the overpaid amounts, the Loan Trust may be vulnerable to attack by HM Revenue & Customs (HMRC). This may mean that any net growth would be treated as within the taxable estate of the settlor. Clearly, any such complication is undesirable and the trustees will need to remember to provide an instruction to cease payments to the settlor once the loan has been repaid. Whilst the loan is being repaid by regular withdrawals under the bond, the trustees will normally request that payments be made directly to the settlor s bank account. Where there are joint settlors, regular withdrawals will normally be made to your joint account. If on the death of the first settlor, the investment bond is not encashed, it s important that any regular withdrawal instruction is updated to reflect new bank account details. You should discuss your circumstances with your financial adviser who will be able to help you decide the best course of action for you. 5

8 SUMMARY SUMMARY OF BENEFITS An arrangement that allows you to retain access to your original capital. The trust can be established by either single or joint settlors with each settlor s loan passing under their own will or the intestacy rules. No inheritance tax charge on creation of the trust. Any investment growth outside your taxable estate from day one. Loan can be repaid in regular instalments to provide you with income or on an ad hoc basis as and when required. Inheritance tax liability will gradually reduce where repayments are made and spent by you as income or gifted within your inheritance tax annual exemption. If no loan repayments are made, inheritance tax liability frozen at current value. Ability to take advantage of potentially exempt transfer regime by waiving part or all of loan at later date if circumstances change. No additional costs in setting up the trust. Tax-efficient investment and simplified administration for the trustees. Easy to complete documentation. Access to a range of supporting material. SUMMARY OF RISKS You have no access to any growth on the investment amount. Once the loan is repaid, you have no further possibility of benefiting from the trust fund (in the form of income or otherwise). Poor investment performance may leave the trustees unable to repay loan. If the loan is not repaid and spent as income, the outstanding amount is an asset of your estate and potentially liable to inheritance tax. Any adult beneficiary may call for the trust fund, or their share of the trust fund, to be paid to them at any time. In these circumstances, the trustees will first repay any outstanding loan to you. This may not be the most opportune time from an investment point of view to cash in the bond. On the death of the first of joint settlors the bond may need to be encashed in order for the trustees to repay the outstanding loan to the deceased settlor s executors, unless appropriate provision has been made in the settlor s will. 6

9 TECHNICAL QUESTIONS & ANSWERS SETTING UP THE TRUST 1. Who can be the settlor? The settlor is the person who establishes the trust. The settlor must be over 18 years of age and of full mental capacity. Scottish Widows will not normally accept a Loan Trust created under a power of attorney. The Loan Trust can be established by joint settlors if the cheque is also in joint names. 2. How is the Loan Trust established? By completing the Loan Trust declaration and loan agreement and making a loan to the trustees you have appointed. The trustees then invest the loan in a Scottish Widows bond. 3. Can I write the cheque for the investment myself or must a trustee bank account be set up to receive the initial loan? We recognise that setting up a trustee bank account purely for these circumstances is not always practical. We will therefore accept a cheque drawn on the account of the settlor. The Loan Trust documentation provides for this. 4. Can a joint cheque be used to establish the Loan Trust? Provided the Loan Trust is established by joint settlors, who must contribute in equal shares, a cheque for the initial loan amount drawn on a joint account is perfectly acceptable. 5. Can existing investments be used to establish the Loan Trust? No. The Loan Trust is designed to be used only where a cash sum is loaned to the trustees who then invest in an investment bond. 6. Is investment restricted to particular products? While the trustees are not restricted in terms of what investments they may make, the Loan Trust is designed to be used in conjunction with a new investment into a Scottish Widows bond. There may be tax implications, additional trust administration and costs where income-producing investments (or assets chargeable to capital gains tax) are added to or held within the trust. 7. Can further loans be made to the trust at a later date? Yes. Further loans can be made and must be evidenced by completion of a further loan agreement (available on request). However, record keeping will then become more complicated and it will often be simpler to establish a new Loan Trust when additional funds become available. This will, in any event, be necessary if the beneficiaries are to be different. Where there are joint settlors, further loans should be made by both of you, on the same basis as the original loan. TRUST ISSUES 8. On the settlor s death is probate (or confirmation) required? Probate will not be required on the settlor s death in relation to the trust fund (provided there is at least one surviving trustee) as no change of ownership occurs. The trustees hold the trust fund as nominees for the trust beneficiaries and this ensures that devolution on death takes place without the need for a transfer of title to assets. Probate or confirmation will be required in relation to any outstanding loan. 9. Who should be appointed as trustee? As settlor, you will automatically be one of the original trustees. At least one other person must be appointed as a trustee. It is, of course, your decision who should be the other trustees to act with you. The other trustees will generally be members of your family. Trustees must be adults of sound mind and should ideally be living in the United Kingdom. In some circumstances it may be appropriate to appoint a professional person such as a solicitor or accountant, although such a trustee may charge for his or her services (and there will be no trust income from which the fees can be met). 7

10 10. Can trustees be removed and new trustees appointed? Yes. During your lifetime you are able to appoint new or additional trustees and, by giving 30 days notice in writing, to dismiss any trustee (provided at least one corporate trustee or two individual trustees remain). Bear in mind, however, that adult beneficiaries can demand payment of the trust fund (after repayment of any outstanding loan) at any time. 11. What happens if one of the trustees dies or no longer wishes to be a trustee? You, or the surviving trustees after your death, may appoint a new trustee to act in place of a trustee who has died. Any trustee who no longer wishes to act may retire so long as a replacement is appointed simultaneously or, if no replacement can be found, there are at least two trustees or a corporate trustee remaining after the retirement. 12. On what terms do the trustees hold the trust fund? The trustees hold the trust fund as nominees for the trust beneficiary or beneficiaries under bare trusts. This means that a beneficiary has a fixed and absolute interest in the trust fund and an adult beneficiary is able to direct the trustees how to deal with the trust property. 13. Who should be the trust beneficiary? The trust beneficiary (or beneficiaries) should be the person (or persons) you intend to benefit from any net growth in the trust fund, after repayment of your loan by the trustees. You may name more than one beneficiary but you cannot subsequently change a beneficiary, or the share in which they benefit. 14. Can I write the trust for a class of beneficiaries for example, all of my grandchildren born in my lifetime? No. All beneficiaries must be identified and named at outset. Otherwise the trust fund would be treated as settled property for inheritance tax purposes and would then be subject to the more complex tax and reporting regime which governs such settlements. 15. What is the position of a beneficiary under a bare trust? A beneficiary of a bare trust who has full legal capacity is able to direct the trustees how to deal with the trust fund and may call for payment of the trust fund at any time (although it may often be appropriate to leave the trust fund in the names of the trustees). As each beneficiary will have a fixed and absolute trust interest, this also means: the beneficiary s share of the trust fund will be treated as an asset in his or her estate for inheritance tax purposes the trust interest would be taken into account in the event of a beneficiary becoming divorced or insolvent the trust interest passes under the beneficiary s will or intestacy (and in some circumstances may thus become comprised again in the estate of the settlor if the beneficiary pre-deceases the settlor) if a chargeable event arises under the investment bond, any chargeable event gains will be assessable to income tax on the beneficiaries unless the bare trust was created by a parent and is subject to the parental settlement rules. In which case the gain will be assessable on the settlor. (If, immediately before the chargeable event, the settlor is deceased, then any chargeable event gain will be assessable to income tax on the minor beneficiaries, even if the settlor s death triggers the chargeable event.) 16. Can I access the trust fund during my lifetime? You are entitled to repayment of your original capital loan (either as one or more lump sums or in regular instalments) but are otherwise irrevocably excluded from benefit under the terms of the Loan Trust. If there are joint settlors, each of you is entitled to repayment of your half share of the original capital loan. 17. Can my spouse/civil partner benefit from the trust fund? No. A spouse or civil partner should not be named as a trust beneficiary as transfers to such a person would, in any event, normally be exempt from inheritance tax. You can arrange to leave the right to demand repayment of any part of the loan outstanding on your death to your surviving spouse/ civil partner (see question 22 for further details). 8

11 THE LOAN 18. How is my original loan repaid to me? The terms of the Loan Trust declaration and loan agreement provide that unless and until otherwise requested by you, your loan (or your part of the loan) will be repaid to you in regular instalments. Repayments can be set at a level and frequency to suit you. The withdrawal instructions given by the trustees in the bond application should match the details inserted in the Loan Trust declaration and loan agreement. 19. Can the loan be repaid to me in one payment? Yes. The loan (or your share of it) is repayable on demand and can be repaid to you in full or part at any time. Full repayment will usually involve an encashment under the bond, which may result in an income tax charge. 20. Are there any tax implications when the trustees withdraw funds from the bond to repay the loan in part or in full? Provided repayments do not exceed the cumulative allowance (5% of the amount invested each year) and a maximum of the amount invested, there will be no immediate liability to income tax on the amounts withdrawn. Where amounts withdrawn exceed the allowable amount in any tax year, a liability to income tax may arise. Advice should always be sought before such withdrawals are made. 21. Can I continue to take income indefinitely? No. Once the original loan (or your share of it) has been repaid to you in full, your income payments must cease. This should be borne in mind when setting the level and frequency of loan repayments. 22. What happens if I die before the loan is fully repaid? Any loan balance owing to you at the date of your death will form part of your taxable estate for inheritance tax purposes and, in theory, should be repaid to your personal representatives for distribution in accordance with the terms of your will or the intestacy rules. It is, however, possible for you to leave the right to future loan repayments to a nominated person (such as your spouse or civil partner) or to waive repayment of the loan in favour of the Loan Trust beneficiaries by will or codicil. You should further be able to provide that your personal representatives need not call in the loan on death. Making specific provision in your will for the devolution of the loan will not affect the inheritance tax position on your death the outstanding loan will still form part of your estate. However, it can give greater control over the timing of any income tax charge on gains under the bond. A draft codicil for consideration by your solicitor is available on request. 23. What should I do if I don t require income at present? If no loan repayments are made, the liability to inheritance tax on the amount invested will be frozen at its present value but will not be reduced. If income is not required, Box F in the Loan Trust declaration and loan agreement should be left blank. 24. Is it possible to take loan repayments but to gift these away to family members such as grandchildren? Yes, but there may be inheritance tax consequences if the amounts gifted exceed 3,000 in any tax year or if the inheritance tax annual exemption has already been used in the relevant tax year. 25. Can I waive repayment of all or part of the loan at a later date? Yes. If you decide at a later date, perhaps after a change in your circumstances, that you have no further requirement for access to all or part of the outstanding loan, you may waive repayment in favour of the trust beneficiaries. Provided the waiver is made by deed, it will qualify as a potentially exempt transfer for inheritance tax purposes and will fall out of account to inheritance tax once seven years have passed. A draft deed of release can be provided on request. 26. Joint settlors and the loan Where there are joint settlors, each of you must contribute a half share of the loan from a joint account. You are each entitled to repayment of your half of the original loan capital. You are able to waive the right to your respective shares of the outstanding loan during your lifetimes. Where you do not waive your right to repayment of your share of the loan during lifetime, any balance owing to you on your death will pass under your will or according to the intestacy rules. It s important that the trustees keep comprehensive records of all repayments so that each of you only receive your respective shares of the outstanding loan. 9

12 INHERITANCE TAX 27. What is the inheritance tax effect of setting up the Loan Trust? There are no inheritance tax consequences of setting up the Loan Trust. As you are not making a gift there will be no reduction in your estate unless and until loan repayments are made to you and either spent as income or gifted elsewhere. In establishing the Loan Trust you are creating bare trusts. The trustees will not therefore be subject to the reporting and tax regime which governs settled property. 28. What is the inheritance tax position on my death? Any loan balance outstanding at the date of your death will form part of your taxable estate for inheritance tax purposes. In the case of joint settlors it will be your individual share of the outstanding loan balance which will form part of your taxable estate for inheritance tax purposes. If the right to repayment of any balance of the loan outstanding on your death is left to your spouse or civil partner, the normal exemption will apply and no inheritance tax will be payable on your death in relation to the outstanding loan. Any investment growth will be outside your taxable estate from day one and can pass to the trust beneficiaries free of any immediate liability to inheritance tax. 30. Is it possible for me and my spouse/civil partner to each create a Loan Trust? Yes, as normally neither you nor your spouse/ civil partner can be a trust beneficiary, separate arrangements are possible. Provision can be made for each other following first death by leaving the right to repayment of any outstanding loan to the survivor. Alternatively, you may wish to consider a joint settlement. Speak to your financial adviser for further information. 31. How might the Loan Trust impact on other planning and vice versa? The outstanding loan remains an asset of your taxable estate for inheritance tax purposes and will use all or part of your nil rate band if passed on death to someone other than an exempt person such as a surviving spouse/civil partner or a registered charity. 32. Is the Loan Trust affected by the Budget 2006 changes which aligned the inheritance tax treatment of trusts? No. Guidance notes issued by HM Revenue & Customs on publication of the Finance (No 2) Bill 2006 confirmed The Finance Bill makes clear that all future as well as existing bare trusts are not affected at all by the changes. 29. Could a liability to inheritance tax arise on the death of a beneficiary? The trust beneficiaries are absolutely entitled to the trust capital (that is, the value of the bond less any outstanding loan amount). This means that if a beneficiary dies, their share of the trust fund will be included in their taxable estate for inheritance tax purposes. Where beneficiaries are likely to have taxable estates in excess of the nil rate threshold, insurance on the lives of the beneficiaries to fund for any tax liability should be considered. It should be borne in mind that if a beneficiary dies without leaving a will and with no surviving spouse/civil partner or issue, the intestacy rules will normally mean that the beneficiary s interest in the trust fund passes to his or her parents. This may have the effect of negating much of the tax planning in relation to any net growth in the value of the trust fund. 10

13 Important. Please read carefully If there is anything you do not understand or if you would like more information about any aspect, please contact us. The information given in this brochure is based on our understanding of UK law and HM Revenue & Customs practice at the time of printing. We accept no liability for the accuracy of the information provided. Legislation regarding taxation and HM Revenue & Customs practice may be subject to change, which cannot be foreseen. The Loan Trust (creating fixed trust interests) is a document with legal significance that may affect the rights, obligations and tax position of yourself and the beneficiaries. You should not proceed unless you are satisfied that you understand its effect and that it achieves your objectives. If you have any doubts or uncertainties you should seek independent legal advice. Special consideration may be required where you are either resident or domiciled outside the UK. References to civil partners are references to individuals who have registered their civil partnership under the Civil Partnership Act

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16 Scottish Widows Limited. Registered in England and Wales No Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number /15