What a loan trust is
A loan trust is a particular form of trust arrangement used in inheritance tax planning. Rather than making an outright gift into a trust — which would be an immediately chargeable lifetime transfer (CLT) or a potentially exempt transfer (PET), depending on the trust type — the settlor makes a loan to the trustees. The trustees invest the loaned money, typically in an investment bond or portfolio, and manage it for the benefit of the trust's beneficiaries.
The crucial characteristic is this: the loan is an asset of the settlor's estate. It does not leave the estate. However, all the investment growth on the loan amount — everything the trust earns above the original loan balance — sits within the trust and passes to beneficiaries outside the settlor's estate. Over time, as the investment grows, the gap between the outstanding loan and the trust's total value widens, and that "gap" represents capital that will eventually pass to the beneficiaries without IHT.
How it works in practice
A settlor who is aged 70 and has an estate well above the nil-rate band lends £200,000 to a trust for the benefit of their adult children. The trustees invest the £200,000 in an offshore investment bond.
Over ten years, assume the bond grows at an average of 5% per annum. The trust fund reaches approximately £326,000. The outstanding loan remains £200,000 (assuming no repayments have been made). The growth above the loan — approximately £126,000 — is held within the trust and is outside the settlor's estate.
On the settlor's death, the estate includes the £200,000 loan as an asset (the right to be repaid that sum). The trust's total value of £326,000 is partly the repayment of the £200,000 loan (which returns to the estate and may be subject to IHT there, depending on the overall estate position) and partly the £126,000 of growth, which passes to the beneficiaries without IHT.
If the investment period is longer, or the growth rate is higher, the IHT-free growth element becomes substantially larger. The loan trust is a patient tool: its benefit grows over time.
The attraction: flexibility
The loan trust's primary attraction for clients who are uncertain about their future financial needs is the flexibility it preserves. Unlike an outright gift into a trust — from which the settlor cannot benefit without triggering a gift with reservation of benefit — the loan trust allows the settlor to reclaim the loan balance in full or in part at any time.
If the settlor's health deteriorates and they need funds for care costs, the trustees repay the loan. If circumstances change and the settlor wants to invest the money differently, the loan is repaid. The settlor does not lose control over their capital.
This is fundamentally different from the discounted gift trust, where the gift into the trust is irrevocable and the settlor retains only a fixed income stream, not access to capital.
The key limitation: the loan never leaves the estate
The loan trust's flexibility is precisely its limitation as an IHT tool. The original loan balance never leaves the estate — it is always an asset, available for repayment, and therefore always potentially subject to IHT. The loan trust does not reduce the base amount invested; it only ensures that growth above that base amount escapes IHT.
For a client who is confident they will not need the capital back, a discounted gift trust or an outright PET into a trust may be more effective: both remove capital from the estate immediately (subject to the seven-year survival rule for PETs), whereas the loan trust only removes future growth.
For a client who has already made full use of their annual exemption and PET allowances, and who does not want to make a further irrevocable commitment, the loan trust is a useful complement to the wider strategy — it generates IHT savings on future growth without requiring any further capital commitment to leave the estate.
Comparing loan trust with discounted gift trust
The discounted gift trust (DGT) operates differently. The settlor makes an outright gift of the investment into the trust but retains a fixed, regular stream of payments — the "retained rights" — usually structured as regular partial surrenders of an investment bond. The value of those retained rights (calculated by an actuary based on the settlor's age, health, and the size of the retained payment) is "discounted" from the value of the gift for IHT purposes on day one. The discounted portion is immediately outside the estate (or enters the seven-year PET clock).
The DGT is better when: the settlor needs a regular income from the investment and is prepared to commit the capital irrevocably to the trust; the settlor is in reasonable health (because the discount calculation depends on life expectancy — poor health means a smaller discount); and the time horizon is finite.
The loan trust is better when: the settlor's primary concern is flexibility and access to capital; the client is older or in poor health (where a DGT discount may be minimal); the client wants to act immediately without giving up control; and the amount to be invested is very large (where irrevocable commitment creates anxiety).
Tax considerations
From an income tax perspective, the trust's investment income and gains are taxed within the trust at trust rates. If an offshore investment bond is used as the investment vehicle within the loan trust, the five per cent annual withdrawal allowance within the bond can be used to make loan repayments to the settlor in a tax-efficient manner.
For IHT, the outstanding loan balance on death is a straightforward asset of the estate. There are no CLT or PET complications from the loan arrangement itself — the trust is typically a bare trust or a simple trust (depending on the trust structure) that does not fall within the relevant property regime, avoiding periodic and exit charges.
Specific structuring must be tailored to individual circumstances. Take specialist legal and tax advice before establishing a loan trust. Arrangements that are not properly structured may be challenged by HMRC. This guide is for information only.
Who benefits most from a loan trust
Loan trusts are particularly well suited to:
Older clients (aged 65+) who are reluctant to make irrevocable commitments but want to begin redirecting investment growth towards the next generation.
Clients who have already used up their NRB, annual exemption, and PET capacity and want an additional planning mechanism.
Clients in moderate or poor health, where the DGT discount would be minimal and the patience of the loan trust is a more realistic planning tool.
Clients who simply want peace of mind that they can access their money if they need to, while still achieving some IHT planning benefit.
How Global Investments can help
Global Investments works with clients and their legal advisers on the design and implementation of loan trust arrangements as part of a comprehensive IHT plan. We can model the projected IHT saving over different time horizons and investment growth assumptions, compare the loan trust against alternative structures (discounted gift trusts, PETs, outright gifts), and manage the trust investment once established. Contact our estate planning team to explore whether a loan trust is appropriate for your situation.
Frequently Asked Questions
This guide is for general information only and does not constitute financial advice or a personal recommendation. The value of investments can fall as well as rise and you may get back less than you invest. Tax rules, pension legislation, and investment regulations change — always verify current rules and seek advice from a qualified independent financial adviser before making any financial decisions.