Alice, 65, was recently widowed following the death of her husband Bert. They always had fairly simple tax affairs, and inheritance tax (IHT) planning was never a priority.
However, with Bert having left everything to her, Alice is concerned there could be a sizeable IHT bill for her two children on her £1.5 million estate. Alice and Bert always assumed IHT planning was for ‘the rich’, and although financially comfortable, did not feel particularly rich as a large chunk of their estate comprised the family home.
A friend suggested she should simply give money to her children, Catherine and David, but Alice is not convinced. She would also like her grandchildren to benefit, and is worried about leaving herself short.
Alice discusses her situation with a financial adviser. First, the adviser explains the IHT rate is zero within nil-rate band (NRB) limits.
The NRB is currently £325,000 and is set to remain at that level until 2020/21. On Alice’s death, her estate will benefit from a double NRB of £650,000 under current figures.
The adviser goes on to explain the residence NRB (RNRB) is an extra NRB if certain qualifying conditions are met. In 2018/19, her estate would qualify for a total RNRB of £250,000, rising to £350,000 by 2020/21.
In summary, a combined NRB of £1 million is available in 2020/21.
Although Alice understands there is a potential IHT liability, she remains unsure about large outright gifts to her children. The adviser informs Alice lump sum gifts to her children are potentially exempt transfers (PETs).
Tax rules state PETs only become chargeable if she dies within seven years. This sounds simple, but Alice can no longer access those gifts if she changes her mind, and her grandchildren are not involved.
Alice’s adviser discusses a loan trust with her and explains it is for clients requiring access to their original capital.
She learns there is a straightforward three-step process.
- Set up the loan trust.
- Lend money, interest free, to the trustees (e.g. Alice, Catherine and David).
- Trustees invest in an insurance bond.
Alice will have full access to her outstanding loan. All the growth is held for the trust beneficiaries and Alice will have no access to that. The growth will not be included within her IHT estate. The outstanding loan remains in her estate for IHT purposes.
The adviser informs Alice that using a loan trust allows her to retain control and access original capital. She can take, and spend, part repayments of her loan via 5% tax-deferred withdrawals.
If she no longer requires access to the whole loan in the future, Alice can waive it in part or in full at any time. Her adviser explains this is an excellent opportunity to use her £3,000 IHT annual exemption. Larger loan waivers will constitute seven-year gifts for IHT purposes. The insurance company may offer a standard deed.
Alice is very interested but asks how her grandchildren might benefit. Her adviser tells her she can set up a discretionary loan trust in which it is up to the trustees to decide who will benefit and when they will benefit from the trust fund. She can lodge a letter of wishes with the trustees to give guidance, after her death, as to how she wants the trust fund divided up.
Alice is keen on the flexibility and decides to set up a discretionary loan trust.
Graeme Robb is a senior technical manager at Prudential