IHT Planning Arrangements Flashcards
What is a loan trust?
Settlor has access to original capital but growth is outside estate
• Settlor establishes discretionary trust
o Makes interest free cash loan to trustees, repayable on
demand
o Trustees buy investment bond
o No transfer of value (because it’s a loan)
o Settlor is a trustee
• Future growth belongs to beneficiaries, therefore outside of estate
o Settlor cannot benefit from it
• Loan must be paid back to settlor on their death
o They can ask for a payment or series of payments at
any time should they need capital / income
o Can use 5% withdrawal to fund this
Though this means the loan will have been repaid
after 20 years
• 10 year anniversary charge
o Amount owed to settlor deducted from value of trust
• Exit charge
o None on loan repayments
• Historically small starter gift into trust made first but HMRC stated not required
• No GWR / POAT as settlor cannot beneficiary
• Not within GAAR remit as established practice
• Settlor can waive their right to loan repayments
o This would be a CLT unless covered by annual
exempt amount
• Loan repayment is due on death
o Personal legal reps bound to call it in
o Cashing in bond to pay could lead to income tax
liability
Could write term in will for loan to be left to spouse
(exempt gift) or trust instead
• Some loan trusts have limited liability clause that if amount in trust is less than amount owed on death this is not a GWR
What are the advantages and disadvantages of a loan trust?
Advantages
o Growth outside estate – capital effectively frozen in value
o Settlor has access to capital whenever they wish
o Can take an ‘income’
Disadvantages
o Outstanding loan remains in estate
o Paid to settlor’s estate on death
o If take 5%, run out of money in 20years
Should plan lower withdrawals if this will be an issue
o If do not spend withdrawals, money remains in estate
o Takes time to benefit (e.g. for growth outside estate, spend capital)
o If trustees make payments to beneficiary (e.g.spouse) must ensure they have enough funds left to make loan repayments
Could assign segments direct to beneficiary to avoid
tax
• Beneficiary pay at own rate
What is a discounted gift trust?
- These are only really suitable for individuals with an IHT problem who need a pre- determined size of capital payment with no requirement for flexibility and are likely to live for at least seven years
- The donor puts their gift into trust subject to a provision that they will receive a fixed payment for life or until the trust fund is exhausted
- An investment bond is typically used as the trust investment so that capital payments can be fixed within the 5% annual allowance
- The transfer into trust is a PET if a bare trust or a CLT for all other types of trust.
- The value of the transfer is less than the amount gifted into the trust because it is discounted to take into consideration the fixed payment streamo The discount will be based on the size of income
payable and the donor’s life expectancyo Providers will medically underwrite the donor at
outset in order to reduce the chances of HMRC
disputing the amount of the discount in the event
of death within seven years, although there is no
guarantee that HMRC will agree with the discount
• In order to be effective, the donor must make sure they spend the income from the trust and not accumulate it, otherwise they just end up increasing the value of their estate for IHT purposes again
Discounted Gift Trust - why use a discretionary Trust?
A DGT can either be written as bare trust or a discretionary trust
o A discretionary trust provides flexibility over the choice of beneficiaries but, depending on the amount placed in the trust, there could be an immediate IHT charge (if the gift, alone or together with other chargeable transfers made within the previous seven years, exceeds the nil rate band) as well as periodic and exit charges (the regular payments to the settlor are not subject to an exit charge).
o On death within seven years of setting up the DGT, the immediate tax charge will be recalculated using the full inheritance tax rate of 40%.
o On encashment of the bond the donor is assessable if they are alive and UK resident, otherwise the tax falls on any UK resident trustees, unless the bond is assigned to the beneficiaries before encashment
Discounted Gift Trust - why use a Bare Trust?
o With a bare trust, the beneficiaries and their share of the trust fund are determined at outset and cannot subsequently be changed. The gift into trust (excluding the discount) is a PET therefore there is no immediate IHT charge (but the situation is reassessed on death within seven years).
o The trust itself will not be subject to any periodic or exit charges, although each beneficiary’s share of the trust fund will be treated as forming part of their estate.
o On encashment the bond is taxed on the beneficiaries as if they individually own the bond
What are the advantages & disadvantages of a Discounted Gift Trust?
Advantages
o Make a gift for IHT but retain a regular income without GWR/ POAT applying
o Transfer value less than amount transferred, immediate tax saving if die in 7 years
o If into discretionary trust and amounts involved under NRB no lifetime/periodic / exit charges
o Whole transfer drops out of estate after 7 years
Discount element drops out immediately
Disadvantages
o Inflexible
If die after 20 years ‘income’ exhausted
o CGT inefficient (because using bond)
o May not permit capital distribution to beneficiary while settlor(s) live
If it does + trustees decide to, tax efficient to
assign whole segments to beneficiary to encash
outside of the trust
Can appoint to settlor’s spouse if it is not a joint policy and they are named as potential beneficiary
Advice points to consider when looking at a DGT
o Life expectancy
Will they survive 7 years?
o Whats the size of the potential IHT liability?
o Could they give capital away outright instead?Would beneficiaries prefer this?
o Do they want/ need income, will they spend it?(If they do not, it just goes back into the estate)
o Is fixed income acceptable? What about inflation? NOTE - cannot be changed if circumstances change
o History of gifting (establish NRB) + other gifts made in last 7 years
o Joint/single names?
o Can waive right to future income–this will be a PET/ CLT depending on type of trust
What is a flexible revisionary trust (FRT)?
- FRT allows an individual to make a lifetime gift for IHT whilst retaining the option to enjoy a flexible payment each year.
- Differs to DGT as the settlor’s carved-out rights are defeasible by the trustees
- Known as revert to settlor trusts with single settlor only
- Settlor makes gift (cash) to single or double flexible reversionary trust and then invests in a number of surrenderable single premium endowments with multiple lives assured
• Double trust
o Settlor assigns endowments to bare trust for own benefit
Then irrevocably assigns beneficial interest of each policy to
discretionary trust
• Single trust
o Settlor assigns endowments to discretionary trust
• Each endowment has its own maturity date, typically spread over ten years
o Settlor access benefits on one day each year (policy anniversary)
• If an endowment is allowed to mature, its value is paid out to the settlor with any tax due payable under the usual chargeable gains rules
• Alternatively, the trustees can decided to let an endowment continue (by extending its maturity date)
o This will not be treated as a new gift from the settlor
• Trustees can also decide to surrender an endowment whenever they see fit in order to make a distribution to a beneficiary
o Even if the settlor is still alive
o If trustees assign the endowment to the beneficiary
first, it will be assessed to tax on them rather than
the settlor
- HMRC has accepted that this is neither a GWR nor a transaction within the remit of POAT
- The initial transfer into trust is classed as a CLT
What are the advantages and the disadvantages of a Flexible Reversionary Trust?
Advantages
o Effective gift for IHT purposes but retain right to receive ‘income’ from it
o Neither GWR nor POAT provisions apply
o Transfer is outside of estate after seven years
o Settlor can receive annual payments if required
o Payments can be made to beneficiaries at trustees discretion
o Growth outside of estate
• Disadvantages
o Transfer remains in estate for seven years
o Immediate charge to IHT if CLT exceeds available nil rate band
o There’s no discount (like there is for DGT)
o At surrender/ maturity, the gain is chargeable to income tax
o Unable to take 5% tax deferred while settlor lives
Advice considerations for a Flexible Reversionary Trust
o Availability of nil rate band (as this affects initial and ongoing IHT charges)
o IHT liability ?
o Any gifts in last 7 years?
o Made any other CLTs in last 7 years - FRT is CLT so it is a cumulative total
o If married, in whose name should the trust be (one each?)
o Can client afford to give money away?
o Do they need regular payments or are they happy with flexible payments?
o Trustees should be carefully chosen as can defeat the maturing policies
o Settlor should spend any money they receive or it will negate purpose of trust
What are back to back arrangements?
• Buy own life annuity and take out own life policy under discretionary trust
• On death, annuity no value for IHT and proceeds of life policy outside estate
• Cash buys annuity and 1st premium on life policy
• Single or JL2D
• Life policy must be underwritten, need to be in good health
• Annuity = purchased life annuity
o Capital content tax free
o Interest element taxed as savings income
• Premiums for life policy CLT
o Can use annual exemption/ normal expenditure out of income
Although capital content of annuity does not count as income
Cannot use normal expenditure if use annuity to fund life policy
unless can show the two policies are not associated
• Annuity can be used to pay premiums and the rest to spend
• On death annuity stops and has no value for IHT
• Life policy pays out to trustees who pay beneficiaries
o Not in estate as under trust
o Policy holder should not be a beneficiary under trust so as to not
give rise to a GWR or POAT charge
• If cannot show that arrangements are not associated then there’s a transfer of value for IHT purposes which will be the lower of:
o Price of annuity plus first premium of policy
o Sum assured/ value of greatest benefit from life
policy
o To demonstrate policies not associated best to
take them out with different life offices
Advantages and disadvantages of back to back arrangements
Advantages
o Can remove large amount from estate
o Annuity pays the life policy premiums and can provide the individual with an income
o The need to buy from different offices can lead to finding best rates
o Trustee can make appointments to settlor’s spouse providing not a settlor themselves
o Can make loan to beneficiaries
Creates debt against beneficiary’s estate on death
Reduce their IHT liability
Drawbacks
o Must be in good health at outset
o Annuities are inflexible
o Need to have capital up front to buy annuity
Life assurance cover in IHT planning
• IHT liability only arises on 2D where UK domiciled spouses/civil partners are concerned
• Life assurance needed for when
o Donor dies after making PET
If within NRB, term assurance to protect NRB
that’s been used up for 7 years while PET still in
estate
If above NRB, also need decreasing term to pay
potential tax due if donor dies within 7 years
o If place life assurance under trust
Uses annual exemption
Reduces tax payable on estate
Provide relatively high payout on death that is
outside estate
WOL policy will payout on death (JL2D for
couples)
By choosing the appropriate trust , proceeds can
pass free of tax to the beneficiaries, providing
them with a fund to pay the IHT due on the
donor’s estate
