Loan Trust IHT Planning UK (2026): Freeze Your Estate and Remove Future Growth Without the 7-Year Rule

A loan trust is a specific type of discretionary trust arrangement used for Inheritance Tax (IHT) planning. Rather than making a gift to the trust (which could create a Potentially Exempt Transfer or a Chargeable Lifetime Transfer for IHT), the settlor LENDS a lump sum to the trust. The mechanics are: (1) THE LOAN: the settlor lends a capital sum (typically £50,000 to £500,000+) to the trust on a non-interest-bearing basis (interest-free loans do not trigger income tax on the benefit-in-kind in this context where the lender is the settlor and the borrower is a trust of which the settlor is not a beneficiary). A formal loan agreement is signed; (2) THE DEBT: the outstanding loan is a debt owed by the trust to the settlor's estate. For IHT purposes, this debt is included as an asset of the settlor's estate (at whatever amount remains outstanding). The loan amount is therefore FROZEN in the estate, it does not grow in value, regardless of investment performance; (3) THE TRUST FUND: the trustees invest the loan in a bond, portfolio, or other investments. Any growth in the trust fund above the outstanding loan balance accumulates inside the trust, OUTSIDE the settlor's estate. This growth is therefore not subject to IHT on the settlor's death; (4) THE IMMEDIATE EFFECT: from day one, any future growth on the invested sum is removed from the estate. No 7-year period is required (unlike a PET). No CLT arises at outset (because no gift is made, a loan is made). Example: a £200,000 loan is invested by the trust. After 10 years the trust fund has grown to £320,000. The estate still includes £200,000 (the outstanding loan). The £120,000 growth is outside the estate. IHT saving on death: 40% × £120,000 = £48,000; (5) THE RETAINED ACCESS: the settlor retains the right to repay the loan, i.e. call in the outstanding capital from the trustees at any time. This gives the settlor access to their original capital if needed (though not to the growth, which belongs to the trust). This distinguishes the loan trust from a discounted gift trust, where the original capital is given away irreversibly; (6) WRITING OFF THE LOAN: the settlor can choose to write off all or part of the outstanding loan. This is treated as a gift for IHT purposes, a PET if made outright to the trust beneficiaries, or a CLT if made to the discretionary trust. Writing off the loan starts the 7-year clock on the gifted amount. Many settlors never formally write off the loan; on death, the loan (or remaining balance) becomes a debt of the estate payable to the estate from the trust.

IHTA 1984 s.103 (and related provisions in ss.102-105) is a critical anti-avoidance provision that can potentially undermine a loan trust arrangement if structured incorrectly: (1) WHAT S.103 PROVIDES: s.103 targets the deduction of debts in valuing an estate for IHT where the debt was incurred in connection with excluded property or where the value of the estate has been artificially inflated. The key risk for loan trusts is whether the debt (the outstanding loan to the trust) can properly be deducted from the estate as a liability; (2) THE GENERAL DEDUCTIBILITY RULE, IHTA 1984 s.162: under s.162, debts are generally deductible from an estate when valuing it for IHT, provided they are incurred for consideration (i.e. something was received in exchange for the debt). The loan trust loan was made for consideration, the trust received the money, so the debt should be deductible; (3) THE S.103 RISK, 'ARTIFICIAL' DEBT: s.103 can deny the deduction of a debt where: (a) the debt was incurred to acquire excluded property (foreign situs property held by a non-UK domiciliary); or (b) the debt was incurred in arrangements which have the effect of reducing IHT and which are caught by the general anti-avoidance rule. The main risk is that HMRC could argue the loan is not a genuine commercial loan (no interest; no repayment schedule; related party transaction). If s.103 applies, the loan is not deductible as a liability of the estate, effectively the trust fund (which was funded by the loan) would be included in the estate; (4) HOW TO MITIGATE THE S.103 RISK: (a) use a properly documented loan agreement; (b) ensure the loan is drawn down at arm's length; (c) use a reputable insurer/provider's structure (Canada Life; Prudential; Royal London; Zurich all offer structured loan trust products with the legal documentation built in); (d) do not make the settlor a beneficiary of the trust (this creates reservation of benefit issues under s.102 and GROB); (e) the trust must genuinely operate as a trust, regular trustee meetings, investment decisions, records; (5) HMRC'S POSITION: HMRC has historically challenged loan trust arrangements in certain circumstances. HMRC's Trusts Settlements and Estates Manual (TSEM) sets out their view. Specialist advice from a tax adviser or solicitor experienced in IHT planning is essential before establishing a loan trust. The risks are manageable when the arrangement is properly structured, but the consequences of s.103 applying are serious.

Loan trusts, PETs, and Discounted Gift Trusts (DGTs) are all IHT planning tools but they suit different circumstances: (1) LOAN TRUST VS PET: a PET (outright gift to an individual) removes the full value from the estate, but only after 7 years. If the donor dies within 7 years, taper relief applies (years 3-7) but the gift may still attract IHT. The loan trust avoids this risk: the loan remains in the estate (no IHT benefit on the loan amount) but the growth is immediately outside the estate, no waiting period. The loan trust is therefore preferred when: (a) the settlor is in poor health or elderly and unlikely to survive 7 years; (b) the settlor needs to retain access to the original capital; (c) the settlor does not want to make an irrevocable gift; (2) LOAN TRUST VS DGT: a Discounted Gift Trust (DGT) is an irrevocable gift of a lump sum into trust, retaining a series of regular income payments (fixed withdrawals, typically 5% of original value per year). The IHT value at outset is 'discounted' to reflect the retained income stream. Key differences: DGT: outright gift, settlor loses access to the capital; retains only the income stream; discount reduces the CLT at outset; 7-year clock starts on the discounted amount. Loan trust: loan, settlor retains full access to original capital; no CLT at outset; no discount mechanism; trust fund grows free of IHT immediately; no 7-year clock on the loan amount. The DGT is better when the settlor is in good health and is happy to give up access to the capital in exchange for a regular income. The loan trust is better when the settlor needs access to the full capital, is in poor health, or cannot make an irrevocable gift; (3) SUITABILITY SUMMARY: loan trusts are particularly suited to: older settlors (70-85+) who need capital access and cannot rely on surviving 7 years; settlors in deteriorating health; settlors with very large estates where eliminating future growth (even without eliminating the loan itself) has a significant IHT impact; (4) THE DOWNSIDE OF LOAN TRUSTS: the loan amount remains in the estate throughout, only the growth is removed. If investments perform poorly, the IHT benefit is minimal. The loan trust is dependent on investment growth. It is not suitable for settlors with limited assets where retaining access to the full loan would mean no IHT reduction.

The death of the settlor triggers several important consequences for the loan trust: (1) THE OUTSTANDING LOAN IS AN ESTATE ASSET: the outstanding balance of the loan owed by the trust to the settlor is an asset of the estate. It is included in the estate at its face value for IHT. If the loan was £200,000 and no capital has been called back, the estate includes £200,000. The IHT rate of 40% applies on this amount (to the extent it exceeds the nil-rate band and any available exemptions); (2) THE TRUST FUND IS OUTSIDE THE ESTATE: the trust fund (which may now be worth significantly more than the original loan) is NOT part of the estate. It belongs to the trust and passes to the trust beneficiaries under the trust deed, entirely free of IHT (subject to the trust's own periodic and exit charges, which are usually modest); (3) THE TRUST'S OWN IHT POSITION: the trust is subject to the relevant property regime (IHTA 1984 ss.58-72): (a) 10-year periodic charge: every 10 years, IHT at a maximum of 6% of the trust fund value (above the nil-rate band) is charged; (b) exit charge: when capital leaves the trust (distributed to beneficiaries), a proportionate exit charge applies. These charges are calculated on the trust fund, NOT on the loan (which is repaid from the trust fund). The trust's 10-year anniversary date starts from the date the loan trust was established; (4) REPAYMENT OF THE LOAN: the trustees repay the outstanding loan to the personal representatives (PRs) of the settlor's estate. This is a debt owed by the trust to the estate, it is paid in cash. The PRs use this cash to fund IHT and estate administration. The estate receives the loan repayment but this is already included in the estate value (no double taxation, the loan was included in IHT calculations, and the repayment is simply cash realising that asset); (5) THE BENEFICIARIES: the trust fund, after repaying the loan and trust expenses, passes to the beneficiaries named in the trust deed. The settlor's will does not govern the trust fund, it passes entirely outside the estate.

The trust fund in a loan trust is a discretionary trust, it has its own tax regime: (1) INCOME TAX WITHIN THE TRUST: a discretionary trust pays income tax at the 'trust rate', 45% on income (2025-26). Dividend income is taxed at 39.35%. The trustees can distribute income to beneficiaries, who may reclaim tax if they are basic-rate or non-taxpayers (using a tax credit voucher). The first £500 of trust income is taxed at standard rates (not the trust rate), the 'standard rate band'; (2) CGT WITHIN THE TRUST: the trust pays CGT at 20% on gains (28% on residential property gains). Each trust has an Annual Exempt Amount (AEA) of £3,000 in 2025-26. Note: if the settlor has established multiple trusts on or after 6 June 1978, the AEA may be split between the trusts (halved if 2 trusts, minimum £600). CGT holdover relief (TCGA 1992 s.260) is available for gains within a discretionary trust on distribution to a beneficiary, the beneficiary takes the trustee's base cost; (3) THE SETTLOR INTERESTED TRUST RISK: if the settlor is a beneficiary of the trust (even contingently), the trust is 'settlor interested' and all income and gains are taxed on the settlor under the settlor-interested trust rules (ITTOIA 2005 ss.619-648; TCGA 1992 s.77). It is critical that the SETTLOR IS NOT A BENEFICIARY of the loan trust. This is a fundamental requirement, if included, the IHT and income tax benefits are both potentially lost; (4) BOND WRAPPERS: most loan trust products use an investment bond inside the trust. This provides: (a) tax deferral on income and gains within the bond (no annual income tax or CGT during accumulation); (b) 5% annual cumulative withdrawal allowance; (c) chargeable event gain on the trust's encashment of the bond, assessed on the trustees at the trust rate (45%), with 20% deemed credit for onshore bonds. Using an offshore bond inside the loan trust further defers tax; (5) ANNUAL TRUST CHARGES: the trustees have administrative obligations, annual trustee meetings, trust accounts, tax returns (SA900). An accountant experienced in trust taxation is recommended.