A Discretionary Loan Trust could be a solution for inheritance tax planning

When I meet a client that is looking for Inheritance Tax (IHT) advice there are a number of possible solutions I may recommend and so I thought it would be useful to discuss them. I am starting today with a Discretionary Loan (DLT) trust.

A DLT reduces IHT over an extended period, typically 20 years, so is more suited to clients in their 50’s or 60’s. A loan is granted to the DLT which is invested on behalf of the beneficiaries. The loan is repaid at the rate of 5% pa, via withdrawals from the investment, which provides an income for the donor. The balance of the loan can be called in at any time.

A Discretionary Trust gives the Trustees full discretion over who will benefit and when. The creation of a loan trust has no immediate tax implications if below the nil rate band, currently £325,000.

So, the benefits to the client are clear. They reduce their IHT liability over time; have flexible access to the outstanding loan should they need it and some flexibility over who the beneficiaries will be and when they can benefit from the trust. The loan repayment will be free of tax. All investment growth benefits the trust and therefore doesn’t add to the donor’s estate. The beneficiaries pay no IHT on the trust fund.

It should always be remembered that the outstanding loan remains part of the client’s estate, and is added back on death. As each loan repayment is made and spent, the liability reduces. If this income is not spent it will remain in the estate and there will be no IHT saving. So, it is critical that the client has a real need to spend the repayments monthly. I always discuss this point with my clients in great detail initially and then annually as part of my regular review service.

Of course, there are rules applying to this type of trust. A 10 year periodic charge (sometimes called anniversary charges) may be payable by the trustees. Beneficiaries may be liable to tax on distribution.

Does a Discretionary Loan Trust provide: IHT savings – YES. Access to the money loaned to trustees- YES. Investment growth outside the estate – YES. Add, remove or change beneficiaries- YES. Alter beneficiaries’ entitlement -YES.

Discretionary Loan Trust deed: I have listed the main points you need to know when setting up this type of trust. The person setting up the trust (the settlor) will automatically be a trustee. A second trustee should always be appointed for obvious reasons. The trust automatically includes a wide range of possible beneficiaries, but I would recommend looking at the classes of beneficiary included and decide whether you want to include anyone who isn’t in one of these classes.

Loan agreement: The client and the trustees complete a loan deed to record the amount being lent to them and to set out the terms. Remember, the loan repayments are made by the trustees taking withdrawals from the underlying investment portfolio. This document forms an agreement between the client and the trustees.

The trustees may well want the underlying investment portfolio to continue after the death of a client as this will give the trustees the flexibility to stay invested once any outstanding loan from the client has been repaid. The investment must therefore be structured appropriately for the trust to continue.

There are other solutions for mitigating the effects of Inheritance Tax and this article is just one of many. Watch out for my next article in this series.

As this is a specialist area of advice it is important to seek out this information from an appropriate financial adviser. Richmond House Group has this specialist knowledge and are always available to answer your questions.

John Merrifield Dip PFS, Cert (CII) MP

This information is provided strictly for general consideration only. No action must be taken or refrained from based on its contents alone. Accordingly no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case. It does not constitute legal or tax advice and must not be treated as such. All statements concerning taxation are based on our understanding of the current law and HMRC practice, and proposed changes, as at the date of publication. Levels and bases of, and reliefs from, taxation are subject to change. The provision of advice in relation to taxation is not a regulated activity.