Loan Trusts and Inheritance Tax UK 2026: How a Loan Trust Works, IHT Benefits, s103 FA 1986 Debt Limitation, Comparison with DGT and PETs
A loan trust freezes your estate at today's value: you lend money to a trust, the loan stays in your estate, but all future growth is outside it — with no 7-year clock and no loss of access to capital.
Estate Freezing — Growth Outside the Estate, Capital Retained
A loan trust is not a gift — it is a loan. The loan stays in your estate. The growth on the investment accumulates outside your estate from day one. No 7yr PET clock. No CLT charge (if loan to a bare trust). You can take loan repayments at any time for living expenses — each repayment reduces your estate as you spend it.
| Feature | Loan Trust | PET (Gift to Individual) | Discounted Gift Trust | Direct Gift |
|---|---|---|---|---|
| Immediate IHT reduction in estate | NO — the loan amount stays in the estate. Only the GROWTH is outside the estate. | NO immediate reduction. The full gift value stays in the estate for 7yr (as a failed PET if donor dies within 7yr). After 7yr: fully outside estate. | PARTIAL — the 'discount' (actuarial value of retained income rights, assessed by HMRC actuary) is immediately outside the estate. Typically 20-50% of the bond value. | YES (immediate) — the full gift value leaves the estate immediately (if an outright gift). But it is a PET — if donor dies within 7yr, it comes back into the estate. |
| 7-year PET clock required | NO — the loan is not a gift. It is a debt owed to the settlor. No 7yr clock. | YES — the full 7yr must run. Taper applies after 3yr (s7(4) IHTA). No IHT saving unless donor survives 7yr from date of gift. | NO for the discounted element (immediately outside estate). The 'gift' element (the undiscounted balance) is a CLT (to a DT) or PET (to a bare trust). If CLT: 20% IHT on excess above NRB on creation. | YES — 7yr from date of gift. If donor dies within 7yr: the gift comes back into the estate at the date-of-gift value. Taper reduces the IHT rate after 3yr. |
| Settlor retains access to capital | YES — the settlor can request capital repayments of the loan at any time (subject to trust liquidity). Each repayment reduces the loan balance (estate value decreases as cash is spent). Capital repayments are NOT gifts — they are loan repayments. | NO — the asset is given away. The donor cannot retain access without triggering GWR (gift with reservation — s102 FA 1986). | YES (income retained) — the settlor retains the right to regular income payments (the 'regular withdrawals'). Capital access is NOT retained (unlike a loan trust). The retained income right is valued actuarially — the 'discount'. | NO — the asset is given away. If the donor retains access, GWR applies (s102 FA 1986) and the gift is treated as remaining in the donor's estate. |
| IHT charge on creation | NIL — the loan is not a chargeable transfer. Lending money to a trust is not a gift. | NIL — a PET is not immediately chargeable (no IHT at the time of the gift). IHT only arises if the donor dies within 7yr. | CLT if to discretionary trust: 20% IHT on excess above NRB at creation. PET if to bare trust. The 'discount' is not a gift (it is retained income) so only the gift element is the CLT/PET. | NIL if PET (to individual). CLT (20%) if to DT. No IHT at date of gift for PETs. |
| Trust/estate administration | Moderate — the loan must be documented (a loan agreement between settlor and trustees); interest (if charged) is income; the trust must be managed; loan repayments tracked. The loan balance must be included in the settlor's estate on death (it is an asset — the trustees are debtors of the estate). | Simple if outright gift — just document the gift. No trust needed. If in trust: trust management applies. | Moderate-complex — requires an actuarial valuation for the discount; the trust must be properly drafted with the retained income mechanism; HMRC may challenge the actuarial discount; requires life assurance bond. | Simple if outright — no trust required. Gift documentation recommended. PET: document the date, value, recipient, and intention. |
| Section 103 FA 1986 risk | POSSIBLE — if the 'loan' is structured so that the consideration for the loan was itself gifted property (e.g., the loan is backed by a bond that the settlor assigned to the trust as part of the same scheme), s103 FA 1986 may prevent the loan from being a deductible debt in the settlor's estate. Result: the loan does NOT reduce the estate on death — you lose both the asset (in the trust) AND the deduction. Requires specialist structuring to avoid. | NOT APPLICABLE — a direct PET is not a loan. s103 not relevant. | POSSIBLE — DGTs are often backed by life assurance bonds with complex structures. s103 FA 1986 analysis required on every DGT. HMRC scrutinises DGTs. | NOT APPLICABLE. |
| Best suited to | Clients aged 60-80 who want to reduce IHT progressively without giving assets away outright; clients who need retained access to capital for living expenses; clients with health issues who cannot rely on surviving 7yr for PETs; clients who want to involve the next generation in investment decisions through the trust. | Younger clients who are confident of surviving 7yr; clients who do not need the asset and can give it away permanently; clients with assets that qualify for BPR (BPR PETs are particularly powerful — the 7yr clock starts but BPR may eliminate IHT anyway). | Clients who want immediate estate reduction (the discount) AND retained income; typically used with life assurance bonds; clients who accept reduced capital flexibility in exchange for the immediate discount. | Simple, clean gifting where the donor does not need the asset; works best with assets that will grow significantly in 7yr (the appreciation is outside the estate from the date of gift). |
Loan trust IHT UK 2026. Loan trust mechanism: settlor lends cash to a bare trust or DT under a loan agreement; loan is an asset of the settlor's estate (owed by the trustees to the settlor); all trust investment growth is outside the settlor's estate; settlor takes capital repayments (loan repayments — not income or gifts) to fund living expenses; each repayment reduces the loan balance and the repaid cash, once spent, reduces the estate. No IHT on creation (cash loan is not a gift; loan to bare trust = no CLT; loan to DT = technically could be CLT but typically structured as bare trust for zero-CLT outcome). s103 FA 1986: debt incurred by acquiring property that is or was the estate owner's property — debt may not be deductible; applies to circular bond-back structures; does NOT apply to genuine cash loans from the settlor's own resources. PET: s3A IHTA 1984 (PETs to individuals); 7yr clock; taper after 3yr (s7(4) IHTA); full gift value in estate for 7yr if donor dies. DGT (Discounted Gift Trust): settled sum with retained income right; actuarial discount (HMRC-approved actuary); discount = PV of retained income rights; immediately outside estate; remaining 'gift' element = CLT (if to DT) or PET (if to bare trust); s103 FA 1986 risk on bond-backed DGTs. GWR: s102 FA 1986 — gift with reservation; if donor retains benefit from an asset they have purportedly given away, the gift is ineffective for IHT; does NOT apply to loan trusts (the loan is NOT a gift); applies to loan trusts where the 'interest-free' loan is treated as conferring a benefit (but note: HMRC guidance confirms interest-free loans to trusts are NOT GWR if properly structured). Loan trust — types of trust used: bare trust (simplest; no DT entry charge; interest-free loan does not = CLT if properly structured); DT (more complex; CLT on any gifts to the DT; loan itself is not a CLT). Loan repayments: tax-free receipts to the settlor (they are repayments of capital, not income); spending the repayments reduces the estate. IHT at death: loan balance is an estate asset (valued at the outstanding loan balance on date of death); trust assets (growth + original loan invested) pass to beneficiaries outside the estate (except for the amount needed to repay the outstanding loan balance). Income tax on loan trust investment: trust pays income tax in the usual way; if using an investment bond within the trust — 5% annual withdrawal (notional gain deferral) from the bond can be used to fund loan repayments. HMRC IHTM20000 series: trust IHT generally.
Loan Trusts and IHT: The Complete Guide
How loan trust estate freezing works in practice — an example
A loan trust's IHT benefit is best understood through a realistic example. The 'estate freezing' effect means the IHT on the loaned amount is fixed at the current value — all future growth is outside the estate. Example: Client aged 68, estate £900k (including £300k investable cash). Concerned about IHT (£900k − £325k NRB − £175k RNRB = £400k × 40% = £160k potential IHT). Sets up a loan trust with £300k lent to a discretionary trust (the trustees invest in a diversified portfolio). Estate immediately after: still £900k (the loan of £300k is an estate asset — the trust owes the settlor £300k). After 10 years (assuming 5% annual growth on the trust investment): Trust value = £300k × 1.05^10 = £488,668. Loan amount still = £300k (or reduced by any repayments). Estate: original assets − £300k loan proceeds (spent or remaining as cash) + £300k loan receivable. Crucially: the £188,668 growth is OUTSIDE the estate. If the settllor has drawn £5k per year in loan repayments (£50k over 10yr): loan balance = £250k. IHT on death (estate now £850k including £250k loan receivable): £850k − £325k NRB − £175k RNRB = £350k × 40% = £140k. Compared to doing nothing: estate £900k + £488k (if they had just held the investment): £1.388m − £500k = £888k × 40% = £355.2k IHT. The loan trust saved: £355.2k − £140k = £215.2k IHT. The saving comes from (a) the trust growth being outside the estate; and (b) the capital repayments being spent (reducing the estate). This is a substantial IHT benefit without the settlor giving away the asset or running a 7yr PET clock.
Section 103 FA 1986 — the debt deduction trap
Section 103 FA 1986 is one of the most misunderstood rules in IHT planning for loan trusts. It applies when: a person is deceased and has a debt that was incurred to acquire an asset — and that asset (or a derived asset) is included in their estate or was given away by the deceased. In that situation, the debt is NOT deductible for IHT (it cannot reduce the estate value). The concern for loan trusts: if the loan trust is structured so that the 'loan' is connected to the gift of an asset (rather than being a genuine independent loan of cash), HMRC may argue that s103 applies and the loan is not a deductible estate debt. In a correctly structured cash loan trust: the settlor lends CASH to the trust. The cash lent was the settlor's own money (not assets given to them specifically for this purpose). The trust invests the cash. On the settlor's death: the loan is a genuine debt owed to the estate by the trust — deductible in the usual way. In a bond-backed loan trust: the settlor acquires a life assurance bond; assigns it to the trust; and the trust makes a 'loan' back to the settlor. This creates a circular arrangement — HMRC scrutinises these. s103 FA 1986 may prevent the 'loan' from being deductible if the bond was the consideration for the 'loan'. Result: the bond is in the trust (outside the estate) AND the 'loan' is not deductible (not a deductible debt) — double IHT problem. Advice: always use a straightforward cash loan to the trust; avoid circular bond-based structures unless specialist advice confirms the s103 position.
Frequently Asked Questions
What is a loan trust for inheritance tax?
A loan trust is an IHT planning structure where the settlor LENDS money to a trust instead of giving it. The loan is a debt owed to the settlor — it remains in the settlor's estate for IHT purposes. But ALL GROWTH on the loan within the trust accumulates OUTSIDE the settllor's estate. This is 'estate freezing': the IHT on the loaned amount is fixed at the current loan balance; future investment growth is not subject to IHT in the settlor's estate. Benefits: (1) no 7yr PET clock (the loan is not a gift); (2) retained access to capital (the settlor can request loan repayments at any time); (3) growth outside the estate from day one. Best for: older clients who cannot wait 7yr for PETs to be effective; clients who need ongoing access to capital; clients seeking progressive estate reduction without immediate loss of assets.
How does a loan trust reduce inheritance tax?
A loan trust reduces IHT through estate freezing: the settler lends money to a trust; the loan stays in the estate at its original value; all growth within the trust is outside the estate. As the settlor takes loan repayments (which are spent), the estate value reduces further. Example: £300k lent to a loan trust; trust grows to £500k over 15yr; settlor draws £10k/yr in repayments (£150k total drawn). On death: loan balance = £150k (in estate); trust has £500k (outside estate). IHT based on £150k (not £500k). Compare to doing nothing: £500k would be in the estate and taxed at 40%. The saving: £500k − £150k = £350k outside estate; tax saving = £350k × 40% = £140k. The loan trust does not eliminate IHT on the original loan amount — it eliminates IHT on all future growth.
What is the difference between a loan trust and a discounted gift trust?
Both are trust-based IHT planning structures but they work differently: Loan Trust: the settlor LENDS money to a trust; the loan stays in the estate (no immediate estate reduction); all growth is outside the estate; settlor can take capital repayments at any time; no actuarial valuation needed; simpler structure. Discounted Gift Trust (DGT): the settlor GIVES money to a trust BUT retains the right to regular income payments; the actuarial value of the retained income rights (the 'discount') is deducted from the gift value — this discount is IMMEDIATELY outside the estate; the remaining 'gift' element is a CLT or PET; income is fixed and cannot be varied. Key differences: DGT gives an immediate estate reduction (the discount); a loan trust does not (estate reduction only comes through growth and repayments). Loan trust: more flexible (capital repayments can vary); DGT: income is fixed (cannot draw more). Both require s103 FA 1986 analysis if backed by a life assurance bond.
What is section 103 FA 1986 and why does it matter for loan trusts?
Section 103 Finance Act 1986 prevents a debt from being deducted from an estate for IHT purposes if the debt was incurred to acquire an asset that is or was in the estate. In a loan trust context: if the 'loan' from the trust to the settlor was effectively the consideration for the settlor assigning a life assurance bond to the trust (a circular arrangement), HMRC may argue that the 'loan' is connected to the transfer of the bond — and therefore not a genuine deductible debt under s103. Result: the bond is in the trust (outside the estate) AND the 'loan' cannot reduce the estate — the settlor ends up with the trust assets outside the estate but also a non-deductible 'loan'. This is a double IHT loss. Simple cash loan trusts (where the settlor genuinely lends cash from their own resources) are generally not affected by s103 FA 1986. Bond-backed loan trusts and complex arrangements should be reviewed by a specialist tax adviser.
Is a loan trust better than making a gift for inheritance tax?
Depends on the client's circumstances. Loan trust vs outright gift (PET): Loan trust: no 7yr clock; retained access to capital; but the loan stays in the estate (only growth is outside); slower estate reduction; simpler (no CLT if bare trust). Outright gift (PET): the full gift value leaves the estate if the donor survives 7yr; taper reduces IHT after 3yr; no retained access; no IHT benefit until 7yr has run. If the donor is young and healthy and can give away assets they will never need: a PET is often more effective — it removes the entire gift value after 7yr, including the original capital. If the donor is older, needs the capital, or cannot rely on surviving 7yr: a loan trust is more appropriate — the growth is outside the estate from day one without any 7yr clock.
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