For example: Jo is 78 and in excellent health for her age. She makes a gift into a DGT of £500,000 and retains a right to withdraw income of 5 per cent a year. Based on factors such as age, health and interest rate assumptions, Jo is deemed to have made a discounted gift of £272,303. That is, she was given a discount of £227,697, creating an immediate IHT saving of £91,078 (40 per cent of the discount). Care: Jo’s entitlement to withdrawals is fixed during her lifetime and she will be unable to demand full access to the capital.
2. Loan trusts, access to capital and caps the IHT bill
The loan trust is a vehicle that allows the settlor access to the capital sum, while any growth on that sum is immediately outside their estate. A loan is made by the settlor to the trustees of a trust (either discretionary or bare). Trustees use this loan to invest into an investment vehicle, typically a single premium investment bond.
The loan amount is not deemed a gift, so will continue to form part of the settlor’s estate for IHT purposes, but as the growth is outside the estate, it effectively caps the IHT bill on day one. Over time, as more money is paid back to the settlor and spent, the less money there will be in their estate for IHT purposes, helping to reduce IHT overtime.
For example: Austin makes an interest-free loan of £1,000,000 into a loan trust. Assuming no loan repayments are made for the first five years and the bond grows at a net rate of 5 per cent, in the first year the growth would be £50,000 and by year five the compounded growth would be £276,281. This would give an IHT saving of £110,512 (40 per cent of £276,281) on death. The original £1,000,000 would be inside the estate and subject to 40 per cent tax, but if any withdrawals are made, this exposure reduces.
Placing policies in trust
One area where advisers do expose themselves to being challenged is when they or their clients don’t place their life insurance policies in trust. By writing the life insurance policy in trust, beneficiaries will be able to access the funds instantly and will not need to wait for probate. Probate can be a lengthy process, and if beneficiaries have to wait several months before they have any access to money, it could cause real hardship and added concern.
Before probate can be granted, the probate fee and any IHT due on the estate must be paid, which could prompt more people to use a life insurance policy as a way of ensuring beneficiaries have access to cash to pay the required fees. Advisers setting up policies specifically for this purpose must ensure they place the policy in trust to enable funds to be paid out instantly without the need for probate.
