Winding Up IHT Loan Trusts and Discounted Gift Trusts

We have covered many times on this site the inheritance tax planning benefits of inheritance loan trusts and discounted gift trusts.  This video deals with winding up or closing down those same trusts. 

Firstly, as a general rule, you should understand that many trusts end/are closed based upon their specific trust wording, whether that is on death or in life and provided all trustees and beneficiaries agree.

What is a Loan Trust?

• You set up a basic trust with £1, usually a ‘Bare Trust’ aka ‘Absolute Trust’ where the benefits of the trust are held e.g., for children. 
• You then lend the trust e.g., £100,000 interest free and repayable at any time.  Remember, this is a loan, it is not a gift, so no 7-year inheritance tax gifting rules.
• The trust then invests £100,000 in an insurance investment bond. 
• As insurance bonds do not produce ‘income’ but only gains (growth), there are no complications with having to pay 45% income tax on the trust as there is no income to the trust. 
• The investment bond hopefully grows, and all the growth is held in trust for your loved ones, inheritance tax free.
• The loan is repayable on your death and paid back to your estate or can be ‘called in’ by you and repaid to you at any time.
• As the bond can also pay out 5% pa of the original investment without creating a tax liability, you may decide to have your loan gradually repaid at 5% pa rather than wait until death or ‘calling in’ the loan.

Result:  You have limited future inheritance taxes by having all growth on your investment outside your estate and in trust for loved ones rather than you getting the growth and therefore, a larger inheritance tax bill.

Wind Up/Close Down A Loan Trust

• You can demand the repayment of your loan at any time.  Your beneficiaries can then either leave the growth in trust for a later date and ‘wind it up’/close it down at any time or on death.
• If all parties, that’s you, your trustees and beneficiaries agree that the trust is to be wound up, you can do this at anytime.  Your loan must be repaid, and the beneficiaries can access their funds early, if they all agree.
• If all are in agreemeent, a simple deed can be drawn up by a solicitor or even a deed 'template' form provided by the insurance bond company to dissolve the trust.

What is a Discounted Gift Trust?

• You invest in an insurance investment bond again (say £100,000) inside a ‘discounted gift trust’, usually a ‘Bare Trust’. 
• The clue is ‘gift trust’.  This is not a loan (as with a loan trust above), this is a gift to the trust that you must survive for 7 years for it to fall outside your estate.
• Insurance bonds then pay 5% pa (of the original investment) to you.  As it is 5% of the original capital being paid out to you, again there is no tax.  It is assumed that the life term of any insurance bond is usually 20 years, 5% x 20 years = 100% of the original capital paid you.  With the balance remaining all being growth.
• When you start the insurance bond, the provider makes an assumption, based upon your age, health etc of what your life expectancy is.  E.g.  10-year life expectancy.
• With a  10-year life expectancy, HMRC accepts that you therefor have an expectation that you are going to receive 10 years X 5% = 50% of the capital back. 
• Therefore, for a £100,000 ‘gift’, you have an expectation of getting back £50,000, so you have not really gifted £100,000 but £50,000. 
• HMRC allows to deemed value for inheritance tax purposes to be £50,000 and not £100,000 from day 1.  You now have a gift that has been discounted by 50% and held in trust for loved ones.  A Discounted Gift Trust.
• If you survive for 7 years and then die, the whole gift falls outside your estate for inheritance tax and you receive your ‘reserved’ payment of 5% pa until death.
• If you die within 7 years, and at any time from day 1, the discounted value of the ‘gift’ for inheritance tax purposes is £50,000 is included in your estate yet the value held in trust for your loved ones is £100,000 plus any growth.

Result: Overnight, you have reduced the value of your investments by, in this case, 50% yet your loved ones will inherit 100% of the value of the investment plus growth inheritance tax free.

Wind Up/Close Down A Discounted Gift Trust

• This is not a loan; it is a gift off money, held in trust for your loved ones on your death. 
• It is therefore not your money, so you cannot ask for your original investment back and cannot wind up the trust.
• As you have reserved a right to 5% pa ‘income’ for life, your trustees and beneficiaries also cannot wind up or close the trust.  It only closes on death.
• Sometimes trust wordings prevent trustees from making payments to the beneficiary whilst the settlor is alive but if the trust does allow it, the trustees may only allow it if a beneficiary is experiencing financial difficulties, and their options are limited.
• Before making any ‘early’ payment to the beneficiary, the trustees will need to make sure that the payment would not affect their ability to maintain payment of the 5% pa for the rest of your life.
• If all are in agreemeent, a simple deed can be drawn up by a solicitor or even a deed 'template' form provided by the insurance bond company to dissolve the trust.

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