Not only does the ‘gift and loan’ IHT strategy not use up any valuable allowances, explains Paul Wilcox, it is uncontroversial because it does not use any ‘clever’ footwork or legislative loopholes either.
Recent times have seen a great deal of media focus around long-term care on the one hand and ‘deliberate deprivation’ on the other – in both cases, as they relate to inheritance tax (IHT) planning.
In reality, most people looking to mitigate a sizeable potential IHT liability are more concerned about retaining access to funds should they need them for later life requirements, including long-term care, but certainly not about deliberate deprivation.
While there are a number of strategies for assisting those with considerable assets to protect them from IHT, the least controversial and arguably most flexible arrangement is often overlooked.
In our experience, a taxpayer with a substantial estate is generally quite shy of placing large sums into a scheme, which involves fixed reversions – typically any of several variations of the traditional discounted gift scheme – because of the impact on their future financial flexibility.
Primarily, the fact that reversions are fixed – in amount and time – and must be taken, thereby putting assets back into the taxable estate, is quite a challenge (unless they are always to be spent).
Then there are the potential tax consequences of any gains that might be taken – either within the reversions or later when the arrangement comes to an end (when gains can effectively be taxed at income tax rates). In the right circumstances, where there is a definite ‘income’ requirement, these schemes can form a part of an effective overall strategy but is there a more satisfactory alternative?
The gift and loan (G&L) arrangement is of a similar vintage but offers many advantages compared with the discounted gift route. The first advantage is it does not use any of the taxpayer’s IHT allowances, other than for a small gift into trust, which can use just a single annual gift exemption. This leaves the modest – but renewable – nil-rate band available for non-discounted highly flexible arrangements.
In the G&L arrangement, a trust is established with a small gift – or even just with a loan – with the taxpayer lending the trustees a substantial amount of cash, which is interest-free and repayable on demand. So not only does it not use up any valuable allowances, it is completely uncontroversial because it does not use any ‘clever’ footwork or legislative loopholes.
Of course, it does rely for its efficacy on any subsequent growth, resulting from investment by the trustees, occurring outside the taxpayer’s estate, while any ‘drawings’ (partial loan repayments) that may be required and called for by the settlor will reduce the amount ‘owed’ back to the estate.
On average and over time, the trust should grow while the outstanding debt should shrink. Clearly this is a ‘slow burn’ situation because this ‘pincer’ movement potentially takes many years to accumulate worthwhile IHT-free assets. That said, any wealthy taxpayer concerned about IHT should be starting their planning early so this time requirement should not be a major issue.
There is little risk in putting substantial funds into such a scheme because the arrangement is incredibly flexible and can effectively be unwound at any stage by the trustees realising assets and repaying the loan. In fact, the ability of the taxpayer to control what repayments they want – and when – is the key to the real benefit of this arrangement.
This brings us back to any future ad hoc and/or unexpected need for funds, which can readily be met from calls by the settlor on as much of their ongoing debt as necessary. Calls for long-term care funding or any other personal or family crisis will generally be covered by the debt element of this arrangement.
Biggest-selling IHT scheme
The G&L arrangement is so flexible and, with those in the know, so popular, that – in terms of monetary assets placed – it remains probably the most used IHT mitigation arrangement offered in the UK today. It is certainly the biggest-selling IHT scheme offered by insurance companies in this country.
This is an interesting thought because the arrangement is often used by personal clients of tax consultants and legal and accounting firms, as well as private banks and family offices, directly invested into collectives.
The point here is that G&L does not have to be established with an insurance bond wrapper for the invested assets. It has traditionally been arranged in this fashion for many historical reasons – ease of reporting (no annual tax returns for the trustees), specific bond withdrawal rules and general convenience for trustees.
There is, however, no longer any overarching reason for using a bond other than for convenience. Establishing a freestanding trust with appropriately experienced trustees and investing directly into collectives – which most such insured schemes do anyway, though indirectly through another layer of charges – is increasingly the way to go for many wealthy clients.
There is another benefit of the directly-invested route for the more thoughtful taxpayer, which is that trustees can subsequently pass collectives out to interest-in-possession beneficiaries – pregnant with any accumulated capital gains – with the benefit of holdover relief. This leaves them able to use their own annual allowances to mitigate any gains tax over future years.
Paul Wilcox is chairman of WAY Tax & Trustee Advisory Services
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