New inheritance tax planning tool

Property value growth means tens of thousands more Britons face hefty inheritance tax bills and Budget changes have made it more difficult to plan for inheritance tax using most trusts.

Bank of Scotland has unveiled a new Loan Trust which offers a lifeline to families wanting to protect their assets for future generations.

Bank of Scotland Head of Wealth Management Chris Haines said it was possible to reduce an inheritance tax liability by making lifetime gifts of capital that reduced the overall value of a taxable estate while still allowing access to the capital.

"Substantial outright gifts are not always desirable or possible as the person may require access to that capital. So this trust can be an effective solution as it enables inheritance tax savings over time while allowing for continued access to the original capital," he said.

"This financial planning tool involves setting up a Loan Trust for chosen beneficiaries (excluding yourself or your spouse or civil partner). You make a loan to the trustees which they place in an investment bond. The loan is interest free but is repayable on demand under a binding legal obligation. You therefore always have access to your capital.

"Any growth on the investment is held outside the estate for the trust beneficiaries. The outstanding loan will remain as an asset of your estate and so potentially be subject to inheritance tax on your death but the loan, and the inheritance tax liability, is reduced as you take repayments on the loan for use as income. You have effectively frozen the inheritance tax liability of your investment at its current value."

Example

Mr T, age 70, establishes a Loan Trust with a loan of £200,000. The trustees repay the loan in annual instalments of £10,000 which Mr T uses to supplement his pension income. No immediate liability to income tax arises as the amounts withdrawn from the investment bond are within the 5 per cent allowable limit (a tax concession of investment bonds).

In the event of Mr T's death, say at age 89, only £10,000 of the original investment remains in his taxable estate. Mr T had the benefit of a tax-efficient income for his retirement and assuming a 6% pa and allowing for charges and expenses, investment growth of £220,000 is held outside his estate and is available to the trust beneficiaries.

The Loan Trust could be suitable for people in the following circumstances:

The estate is liable to inheritance tax on their death
They are unable or unwilling to make outright gifts as they may require current or future access to their original capital on either a regular or ad hoc basis
They have a lump sum available for investment
They are willing to forego access themselves to any future growth on the amount invested
They are willing to make a decision now on who should benefit from any future growth on the amount invested

Bank of Scotland research, based on recently released data from HM Revenue & Customs, shows the total number of estates paying inheritance tax (IHT) rose by 72% over the five years to 2003/04 to 30,451.

The Government's own estimates suggest a further 22% increase in the number of estates paying the tax by the end of 2006/07. More estates are now paying IHT as the threshold for the tax has failed to keep pace with the increase in property prices over the past decade.

Inheritance tax revenue for Inland Revenue hit a record £1.7bn in the first half of 2006, up £200m or 13% from the first half of 2005.