The taxpayer sets up a trust in his/her lifetime, often with a nominal sum, say £10.
The trust can take many different forms, but in all cases it is vital that neither the taxpayer nor his/her spouse (or civil partner) are potential beneficiaries. Other family members will usually be included in the class of people who can or will definitely benefit, such as children, grandchildren, their spouses or partners etc.,
The taxpayer then lends funds to the trust, which has a separate legal identity, say £500,000.
The terms of lending will often be that the loan is made interest free and to be repayable on demand.
The trustees (the people in charge of managing the trust fund) then invest the £500,000 in one or more ways, including options such as a single premium life assurance investment bond, from which withdrawals can be made regularly, which can in turn fund partial repayments of the loan to the taxpayer, and indirectly a regular income stream
What is the point of this?
- The growth in value of the trust fund which has been invested takes place outside the taxpayer’s personal estate and is not part of his/her taxable Inheritance Tax (IHT) estate.
- Because the taxpayer can call for repayment of the loan at any time, he/she has arguably not made any transfer of value for IHT purposes at all.
- It is vital the taxpayer does not simply accumulate the loan repayments in his/her estate as otherwise future IHT problems are being created – the loan repayments should be spent, for example on meeting living expenses, or used to fund other available annual IHT reliefs on gifts to others.
- The trust has a separate tax regime. Theoretically, a charge to IHT may arise every 10 years (maximum, if you have not planned properly of 6% (current rates) of the value of the assets in the trust). However, the trust may enjoy its own Nil Rate Band for IHT purposes, if proper advice has been taken on timing – worth up to £325,000 tax free, and whatever amount of the loan has not been repaid is a debt owed by the trustees, and therefore has to be deducted from the value of the trust investments to arrive at the value of the trust assets that could incur a 10 year charge.
- The net result will often mean that little or no IHT has to be paid by the trust.
Finally, the making of the loan to the trust is not a “transfer of value” for IHT purposes by the taxpayer, who has only “given away” £10 to start the arrangement. Furthermore, the taxpayer does not need to worry about whether or not he/she will survive for 7 years after setting up the arrangement. The taxpayers’ personal Nil Rate Band for IHT is therefore preserved and can be used to fund lifetime gifts or other planning.