In the April issue of the Tech Notebook the effects of the new UK Budget proposals for the IHT treat...
In the April issue of the Tech Notebook the effects of the new UK Budget proposals for the IHT treatment of trusts were examined. At the time of writing, the Finance Bill clauses were due to be debated in the Parliamentary Standing Committee and, although many amendments have been tabled by the opposition, it is unlikely the Government will significantly alter the main proposals.
In view of this, it is probably useful to look in more detail at some of the market's main insurance-based IHT planning products and how these may fare under the new regime, starting with loan trusts.
Loan trusts are a well-tried and tested method of reducing one's estate for IHT while giving access to capital without breaching the gift with reservation rules. They work by settling capital as an interest free loan on flexible trusts, of which the settlor is not a beneficiary. The loan is repayable on demand, so the settlor can continue to benefit from his capital in the form of loan repayments from the trustees. All growth is outside the estate, and, over time, the settlor's IHT liability should reduce, and an IHT free pot of capital should build up for the beneficiaries.
Under the new regime, loan trusts should fare well because the settlor will not be subject to the lifetime IHT charge as the initial transfer into trust will not be a chargeable transfer of value (providing they are loan-only schemes). This means unlimited amounts can be placed in a flexible trust without creating an entry charge.
For the purposes of the periodic charge, the chargeable value will be the value of the fund, less outstanding loan amounts due to the settlor. This means there may be little or no periodic charge on the first 10-year anniversary, or even at all. The table below illustrates the position for an investment of £100,000, £200,000 and £500,000.
The periodic charge will not be an issue on a £100,000 investment and only becomes a minor issue on a £200,000 investment on the 40th anniversary. Even on a £500,000 investment, in percentage terms the charge is relatively minor.
The exit charge is based on the periodic charge, so if capital is distributed to beneficiaries, there would be no charge on a £100,000 and £200,000 investment (except after the 40th year). Loan repayments to the settlor would not be subject to an exit charge, as his interest does not form part of the settlement.
For large investments, it would be possible to reduce or eliminate the periodic charge by creating more than one trust on different days - using the so-called "Rysaffe" principle. This is because each trust would have its own nil-rate band to offset against the value of the fund and, because the original settlements were not transfers of value, the earlier trusts would not erode the nil-rate band of the later ones.
For example, if £500,000 was instead invested in five different loan trusts, then there would be no periodic charge in the first 40 years, saving the trustees a total of £101,172. This would be conditional on the trusts not being treated as "related settlements", which they should not be following the Rysaffe case.
The above information is based on Friends Provident's analysis of Revenue Budget Note 25 issued on 22 March 2006 and the relevant draft clauses contained in UK Finance Bill 2006. The proposals are not guaranteed to become law.
Joined as head of strategy, multi asset, in June
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