IHT Loan Trusts: How an Interest-Free Loan to Trustees Removes Growth from Your Estate
In a loan trust, the settlor makes an interest-free loan to trustees who invest it. Only the outstanding loan balance stays in the estate — all investment growth is outside. Unlike a discounted gift trust, the settlor can recall the loan at any time, making the loan trust the more flexible (but less immediately IHT-efficient) option.
How a Loan Trust Works
Step 1: The settlor makes an interest-free loan to the trustees
The settlor (often called the 'lender') transfers a sum of money to trustees under a loan trust deed. Crucially, this is a loan — not a gift. The loan is interest-free (no interest is charged by the settlor to the trustees). Because it is a loan and not a gift, there is no transfer of value for IHT purposes on entry — the full loan amount remains in the settlor's estate as a debt owed to them by the trust. This means there is no immediate IHT charge and no 7-year clock starts.
Step 2: The trustees invest the loan
The trustees invest the loan in a suitable investment vehicle — typically a life assurance investment bond, OEICs, or other assets. The investment grows within the trust. All growth on the investment is outside the settlor's estate from the moment the loan is made — only the outstanding loan balance remains in the estate. Over time, as the investment grows, the gap between the trust fund value and the outstanding loan balance (the 'surplus') increases. This surplus is entirely outside the estate and will pass to the beneficiaries on the settlor's death (or when the trust distributes).
Step 3: The settlor can request repayment of the loan
The settlor can request repayment of the loan at any time — in full or in instalments. When the trustees repay part of the loan, the cash passes to the settlor and the outstanding loan balance in the estate reduces. However, the cash in the settlor's hands is now in the estate — so repayment transfers the estate value from the loan (in the estate) to cash (also in the estate). The IHT position of the estate does not immediately improve when the loan is repaid — but the settlor can then spend the cash (reducing the estate) or reinvest it. The key flexibility: the settlor is not locked into a fixed withdrawal like a DGT — they can access capital if needed.
Step 4: On the settlor's death
When the settlor dies, the outstanding loan balance is a debt of the trust that must be repaid to the estate. The loan balance is therefore an asset of the estate and is subject to IHT. The trust fund in excess of the loan balance (the growth) passes directly to the beneficiaries — outside the estate. The estate pays IHT only on the loan balance, not on the full original investment plus growth. If the settlor has requested repayments over the years (and spent them down), the loan balance is correspondingly lower. If the settlor dies with the full loan outstanding, the estate receives the full loan back from the trust.
Frequently Asked Questions
Is there any IHT charge when a loan trust is set up?
No — because the settlor makes a loan (not a gift), there is no transfer of value and no IHT charge on entry. The full loan amount remains in the estate as a creditor right (a debt owed to the estate by the trust). There is no 7-year PET or CLT, no discount calculation, and no entry charge. This is both an advantage (no immediate IHT exposure) and a limitation (the loan balance stays in the estate until repaid or written off). Contrast with a discounted gift trust: a DGT involves a genuine gift that starts the 7-year clock and provides an immediate actuarial discount — but the settlor cannot access the capital invested (only the fixed withdrawals).
What IHT is saved by a loan trust?
The IHT saving from a loan trust comes from the investment growth being outside the estate. Suppose the settlor lends £500,000 to the trust and the trust fund grows to £750,000 over 10 years. The £250,000 growth is outside the estate — saving £100,000 in IHT (at 40%). If the settlor had simply invested the £500,000 in their own name, the full £750,000 would have been taxable. The longer the trust runs and the higher the investment growth, the greater the IHT saving. However, the loan itself (£500,000 or the outstanding balance) remains in the estate throughout. To remove the loan from the estate, the settlor must either: (a) request repayment and spend the cash; or (b) write off the loan — which is then a gift (PET or CLT) and starts the 7-year clock.
Can the settlor write off the loan to increase the IHT saving?
Yes — but writing off the loan converts it from a creditor right in the estate into a gift to the trust beneficiaries. Writing off all or part of the loan is a potentially exempt transfer (PET) if the trust is a bare/absolute trust, or a chargeable lifetime transfer (CLT) if the trust is discretionary. The 7-year clock starts on the date of the write-off. Writing off the loan is therefore an additional IHT planning step that removes the loan balance from the estate — but it requires the settlor to be willing to give up access to the capital entirely and to start (and ideally survive) the 7-year clock. Many loan trust plans contemplate a phased write-off strategy: the settlor writes off tranches of the loan over successive years, each within the NRB, to progressively remove the loan from the estate without an immediate IHT charge.
Does a loan trust involve a discretionary or a bare trust?
Both structures are used, with different consequences: (1) Bare trust (absolute trust): the beneficiaries are fixed and named at outset. There are no ongoing IHT charges (no 10-year periodic or exit charges) because the trust is not relevant property. The loan write-off is a PET. Simpler and lower cost. Less flexible for the trustees. (2) Discretionary trust: the trustees have discretion over who benefits and when. Subject to the relevant property regime — 10-year periodic charges (up to 6%) and exit charges on distributions of trust capital. The loan write-off is a CLT. More flexible for the trustees but more complex and potentially with ongoing IHT costs. For most loan trusts aimed at IHT planning where the beneficiaries are already known (e.g. children), a bare trust is simpler and avoids ongoing IHT charges on the growth outside the loan.
What happens to the loan trust if the settlor needs the money back urgently?
The full flexibility of the loan trust is that the settlor can request repayment of any part or all of the outstanding loan at any time — the trustees must repay from the trust fund. If the trust fund has grown significantly, the trustees may need to encash investments to fund the repayment. If the trust fund has fallen in value (negative investment performance) and is worth less than the outstanding loan, the trustees can only repay what the trust holds — the remaining loan becomes an unsecured debt of the trust with no guarantee of recovery. This is a risk of loan trust arrangements: if the investment performs poorly, the loan balance (still in the estate) may exceed the trust fund, leaving the estate with a bad debt rather than a creditor asset. The investment risk is therefore borne by the settlor as creditor.
How does a loan trust interact with the estate for IHT purposes on death?
On the settlor's death, the IHT position is: (1) The outstanding loan balance is an asset of the estate — it is a debt owed by the trust to the estate. The executors claim the outstanding balance from the trustees. (2) The trust fund in excess of the outstanding loan (the growth element) passes to the beneficiaries under the trust terms — outside the estate and free of IHT. (3) The estate pays IHT on the loan balance (and other estate assets) in the usual way. Example: £500,000 loaned, trust fund now £800,000 at death, outstanding loan balance £400,000 (£100,000 written off 3 years ago — taper relief applies). Estate: £400,000 loan balance (plus other assets). Trust beneficiaries receive: £800,000 trust fund − £400,000 loan repayment to estate = £400,000 free of IHT. The £400,000 that was written off (as a PET 3 years ago) may also be taxable if the settlor does not survive 7 years from the write-off.
Keeping Investment Growth Out of Your Estate
A loan trust removes future growth from your estate while preserving access to capital. Combined with a well-drafted will, it forms part of a comprehensive IHT plan. A WillSafe will kit gives you the estate planning foundation.
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