Loan Trusts for IHT Planning: How They Work and When to Use Them

A loan trust is one of the most straightforward and widely used IHT planning structures available to UK individuals who want to reduce their estate without giving up access to capital entirely. Unlike a discretionary trust funded by an outright gift (a chargeable lifetime transfer subject to IHT at 20% above the nil-rate band), a loan trust involves a loan to the trust — not a gift — and therefore creates no immediate IHT charge.

The structure is simple, robust, and well-established. It is not a tax avoidance scheme; it uses ordinary principles of trust and loan law.

The Core Concept

When you lend money to a trust, the loan creates a debt in your estate. The loan balance remains in your estate until repaid. However, all investment growth on the trust's assets accrues to the beneficiaries of the trust — outside your estate.

Example:

• You lend £500,000 to a discretionary trust for your children and grandchildren.
• The trustees invest the £500,000.
• Over 15 years, the trust grows to £1,200,000.
• The loan balance remains £500,000 (your estate includes a debt owed to you by the trust).
• The £700,000 growth has accrued to the trust — outside your estate.
• On your death, your estate includes the £500,000 loan asset (subject to IHT at 40% = £200,000 IHT); the £700,000 growth is not in your estate.
• Without the loan trust, your estate would have included £1,200,000, with IHT of £480,000 (assuming the full amount is above the nil-rate band).

The IHT saving on the growth element is substantial — in this example, £280,000 saved on the £700,000 growth.

Key Features

No Gift — No PET, No CLT

Because the arrangement is a loan (not a gift), there is:

• No potentially exempt transfer (PET) — no seven-year clock to worry about;
• No chargeable lifetime transfer (CLT) — no immediate 20% IHT charge above the nil-rate band;
• No depletion of the nil-rate band.

This distinguishes the loan trust from a discretionary trust funded by an outright gift.

The Loan Balance Stays in the Estate

Unlike a gifted trust, the loan balance does not leave your estate. It is an asset of your estate — a debt owed to you by the trustees. On your death, the outstanding loan balance is included in your estate at its full nominal value and is subject to IHT at 40%.

This is not a disadvantage — it is the mechanism by which the freeze is achieved. You started with £500,000 in your estate; you end with £500,000 (the loan) in your estate. The growth has escaped.

Repayments from the Trust

You can request repayment of part or all of the loan at any time. This provides flexibility — if you need capital, you can draw it down from the trust.

However, repayments are returned to you (into your estate), so withdrawing funds and not spending them simply repatriates assets back into the IHT net. The loan trust works best when repayments are actually spent — consumed — reducing both the loan balance and your estate simultaneously.

A common pattern: set up a loan trust in your 60s; draw regular annual repayments (perhaps equal to your annual expenditure above pension/other income); spend the repayments on holidays, gifts within exemptions, or lifestyle costs. The loan balance falls each year, and your estate shrinks progressively.

Trust Structure

The trust associated with a loan trust is typically a discretionary trust. The class of beneficiaries is defined broadly (children, grandchildren, and potentially their spouses), and the trustees have full discretion over the timing and amounts of distributions.

Trustees: At least two trustees are recommended. You (as the settlor/lender) can be a trustee — you are not excluding yourself from the governance of the trust. You simply cannot be a beneficiary.

Trust deed and loan agreement: Two separate legal documents are required:

1. A trust deed establishing the discretionary trust;
2. A loan agreement between you (as lender) and the trustees (as borrowers), specifying that the loan is repayable on demand, interest-free (or at commercial rates), and secured (or unsecured).

Interest-free loan: The loan does not need to bear interest. HMRC accepts interest-free loans to trusts as legitimate — there is no benefit-in-kind charge or deemed interest income on an interest-free loan to a family trust, unlike the rules for certain other interest-free loan arrangements.

Tax Treatment

Income Tax

Investment income arising within the trust is subject to UK income tax at trust rates:

• Interest and non-dividend income: 45% (trustee rate above the first £500);
• Dividend income: 39.35% (dividend trust rate).

Distributions of income to beneficiaries carry a 45% tax credit; beneficiaries reclaim against their own income tax rate if lower.

Important: The investment growth inside the trust should be directed towards capital accumulation (via accumulation units of funds, bond investments, etc.) rather than income, to minimise trust income tax. An offshore investment bond held within the trust is particularly effective — the 5% annual withdrawal allowance under the bond can provide tax-efficient distributions to beneficiaries.

Capital Gains Tax

Capital gains arising within the trust are taxed at trust CGT rates (currently 24% for trustees on non-residential property and securities). The annual CGT exemption for trusts is £1,500 (reduced from higher amounts in recent years).

Holdover relief: When the trust transfers assets to beneficiaries, CGT holdover relief may be available — deferring the CGT charge until the beneficiary disposes of the asset.

IHT Ten-Year Charges

A discretionary trust is a relevant property trust for IHT purposes. It is subject to:

• Periodic (ten-year) charges: Up to 6% of the trust's relevant property value above the nil-rate band at each ten-year anniversary;
• Exit charges: Proportionate charges when property leaves the trust.

Crucially: The loan to the trustees is a liability of the trust, not trust property. The trust's relevant property for the ten-year charge is the investment value above the loan balance. So in the early years of a loan trust, when the growth is modest, the ten-year charge is very small or zero.

As the trust grows and the loan balance is repaid, the relevant property value increases — as does the ten-year charge. This is the natural trade-off of the structure.

Compared with Other IHT Structures

Feature	Loan Trust	Discounted Gift Trust	Outright Discretionary Trust
Gift into trust?	No — loan	Partial (discounted gift element)	Yes
PET/CLT?	No	CLT on the gift element	CLT
Access to capital?	Yes — demand loan	Limited annuity	No
IHT on loan?	Yes — in estate	Actuarially discounted	Falls out after 7 years
Ten-year charge	On growth above loan	On discounted trust	On full trust
Simplicity	High	Medium	Medium

When Is a Loan Trust Appropriate?

A loan trust is particularly well-suited to:

• Individuals who want to freeze their estate but retain access to capital — the demand loan feature provides genuine flexibility;
• Individuals who cannot commit to an irrevocable gift for personal or financial reasons;
• Those who have already used their nil-rate band for outright discretionary trusts and wish to supplement without incurring further CLTs;
• Older individuals for whom the seven-year PET clock is less attractive — the loan trust freezes the estate without requiring them to survive seven years.

It is less effective for individuals who intend to retain the entire loan and not draw it down — in that case, the loan remains in the estate at full value and the IHT saving is only on future growth.

Tax rules and trust law are complex. Seek advice from a qualified UK tax adviser and a solicitor experienced in trust law before implementing a loan trust. This article reflects legislation as of June 2026.

How Global Investments Can Help

Loan trusts are a well-established part of IHT planning for HNW clients. Global Investments advises on the suitability of loan trust structures as part of a comprehensive estate planning review, co-ordinates with specialist private client solicitors for trust drafting, and advises on the investment of trust funds (including the use of offshore bonds for tax-efficient accumulation). Contact us to begin a review of your estate planning arrangements.