Gift and loan plans: what to do on death?
Gift and loan plans, or loan plans, are regularly used in estate inheritance tax (IHT) planning particularly if an individual wishes to reduce the IHT liability on their estate but also wishes to retain the ability to receive an “income” from the amount gifted through repayments of the loan. In this article we look at what happens on the death of the person who has set up the gift and loan plan (the donor).
Gift and loan plans/loan plans: what are they?
Most readers will be familiar with this type of estate planning. In a gift and loan plan the individual wishing to save IHT gives a small amount (typically £3000, equivalent to the IHT annual exemption) to a discretionary trust. They then loan a much larger sum to the trustees of the discretionary trust who invest it in an investment bond, often held offshore. Repayments of the loan are subsequently made to the donor utilising the 5% tax free withdrawal facility. The expected capital growth on the amount invested takes place outside of the donor’s estate and the donor is free to spend the loan repayments as they wish. In a loan plan no initial gift is made.
The IHT position on the donor’s death
On the donor’s death the value of the investment bond in the trust is outside of their estate but any unspent loan repayments, and the balance of the undischarged loan, will be potentially subject to IHT in their estate. Some donors include provisions in their Will as to what is to happen to the unrepaid loan, and this is advisable as the loan is not then available to pay estate expenses, but what happens if the Will is silent?
If no specific provision is included in the donor’s Will, the benefit of the loan will fall into the residue of the donor’s estate. The burden of the loan will rest with the discretionary trust, the beneficiaries of which may differ from the residuary beneficiaries. If the executors of the estate or the residuary beneficiaries ask for the whole balance of the loan to be repaid, the discretionary trust trustees will have to surrender part of the investment bond to do this with a possible charge to income tax under the chargeable events legislation.
What other options exist on death?
In the absence of any specific provision in the will, if it is wished to avoid a forced surrender of part of the investment bond, the best course of action will inevitably depend on the individual circumstances of the particular estate and trust, but broadly there are three potential courses of action:
- Leave the loan in place: the residuary beneficiaries would have to agree to this course of action but the loan could remain in place with the trustees making repayments to the beneficiaries in the same way as before the donor’s death. The loan would be appropriated to the residuary beneficiaries of the estate. The existence of the loan would continue to be a liability of the trust which could reduce any potential IHT periodic charges on the trust (see below). The loan would be an asset of the residuary beneficiary’s estate, depreciating as repayments are made provided these are spent.
- The residuary beneficiaries could, once the loan has been appropriated to them from the estate, waive the benefit of the loan in favour of the discretionary trust: this would be a chargeable transfer for IHT purposes by the beneficiaries and so would need careful consideration.
- A deed of variation could be drawn up within two years of the deceased’s death incorporating a gift into the donor’s Will, leaving the benefit of the loan to the discretionary trust trustees for the benefit of the trust. The gift would use some of the deceased’s IHT nil rate band but would mean that the loan would be outside of the residuary beneficiaries’ estates.
If the deceased had made substantial gifts in the seven years before their death then there may be insufficient of nil rate band to use against the gift. As this would potentially give rise to an IHT charge on an estate (which might otherwise be free from IHT because of the spouse exemption) care would need to be taken in these circumstances.
The trustees and the beneficiaries will need to consider the comparative tax position of the above options in order to make the best decision. It should also be noted that if the assets in the trust exceed 80% of the IHT nil rate band then an IHT return will be required every ten years on the anniversary of the trust’s creation. If the value of the trust assets at that point exceeds the IHT nil rate band there will be an IHT charge at a maximum rate of 6%.
We are increasingly seeing cases where loan plans have not been considered during deceased client’s will planning nor during the administration of the estate. This is generally where the solicitors dealing with the wills or estates are unfamiliar with loan plans and the consequences of them.
The preferred course is for the Wills to make provision for the loan plans. This simplifies the administration of the estate and the taxation consequences for the loan plan and means that there is no need to disturb the underlying loan plan investments.
We recommend that the wills of clients with loan plans are reviewed to ensure that there is adequate provision. If there is insufficient provision a codicil is a cost effective remedy if a full will review is not otherwise appropriate.