We explain, simply and clearly, what a loan trust does and why people choose it.
Many homeowners want to protect family wealth without feeling they have given everything away. A loan trust can suit those who want to keep access to original capital while moving future growth outside their estate for IHT.
It is not a magic wand. The outstanding loan still sits in the settlor’s estate. That means some value remains liable to IHT.
Most setups place an investment bond inside the trust so growth builds outside the estate from day one. Withdrawals from the bond can be used to repay the loan, giving practical access to funds.
We will set out who tends to benefit, who may not, and the main choices you will face: type of trust, trustee selection, and whether to waive the loan later.
Key Takeaways
- Loan trusts let investment growth sit outside your estate, helping reduce IHT exposure.
- The outstanding loan usually remains in the settlor’s estate and may affect IHT.
- Commonly used with investment bonds to balance access and protection.
- Choice of trust type and trustee matters for outcomes and control.
- Watch registration, bond risks and chargeable event gains to avoid surprises.
What a loan trust is and why it’s used for inheritance tax planning
A common wish is to ringfence future growth without giving up access to the original capital. We explain this plainly so the idea feels practical, not technical.
The core idea: access to original capital, growth outside the estate
At its simplest, you lend cash into a trust and keep the right to reclaim that outstanding sum. Any growth on the investment sits separately and aims to fall outside your estate for inheritance purposes.
Key points:
- You retain access to the outstanding sum, usually interest-free and repayable on demand.
- Growth is intended to be held for beneficiaries and not treated as yours.
- That clear boundary — capital return only — is what makes the structure work.
Key roles: settlor, trustees and beneficiaries
The settlor provides the initial capital and records the repayment right. Trustees hold and manage the investments. Beneficiaries receive the benefits the trustees allow.
“Settlor keeps repayment rights; trustees choose distributions; beneficiaries get the growth.”
When people consider this in estate planning
We often see loan trusts discussed when there is spare cash and concern about estate exposure on second death. It suits families that want protection but need practical access to funds.
- Adult children and grandchildren to benefit later.
- Blended families where control and fairness matter.
- Clients wary of gifting outright but seeking a first step into estate planning.
How a loan trust works in practice with an investment bond
An investment bond often sits at the heart of a loan structure because it keeps growth separate while letting cash be taken back when needed.
Why bonds are common: they simplify administration and often allow tax-deferred withdrawals. Withdrawals within the 5% annual cumulative allowance usually create no immediate income tax charge.
Understanding the 5% allowance and repayments
The 5% allowance lets you withdraw a set amount each year without triggering income tax. Unused allowance rolls up and can be used later.
Practical point: adviser charges paid from the bond reduce that allowance. That means less cash can be taken tax-free in the same year.
When withdrawals exceed allowances
Taking more than the allowance can cause chargeable event gains. Those gains are taxed under bond rules and may generate an income tax bill.
Who usually pays the tax
During the settlor’s lifetime, gains are generally assessed on the settlor if they remain alive and resident in the UK. Trustees often weigh partial withdrawals against encashing whole policy segments because the method affects the final amount taxed.
“Small, planned withdrawals can fund home repairs while still keeping growth outside the estate.”
Setting up the trust correctly in the UK
Getting the sequence right at the start saves worry and costly corrections later.
Correct order:
- Create the trust deed and appoint trustees.
- Execute the loan advance to those trustees.
- Trustees apply for the investment bond in the name of the trust.
Why this order matters. Trustees must legally exist before they own or apply for assets. If the bond predates the deed, HMRC may question the arrangement and that can cause problems at IHT purposes reviews.
Existing bonds and new monies
Most providers will not accept an existing bond being transferred into a trust without tax consequences. That is because transferring ownership can create chargeable events.
In practice, trustees often ask the settlor to pay the bond provider directly. This counts as “new monies” that satisfy the loan to trustees without creating an immediate transfer of value.
Topping up: further loan or gift?
Top-ups by further loan usually do not create a transfer of value. Gifts, however, are PETs or potentially CLTs from the date of topping up and may affect thresholds and future IHT charges.
Quick checklist to keep:
- Signed trust deed with date and trustees named.
- Loan agreement or advance records and transfer receipts.
- Bond application dated on/after the deed.
- Clear notes if further funds are loans or gifts.
If you would like step‑by‑step guidance, see our setting up a trust guide.
Choosing the right structure: absolute loan trust vs discretionary loan trust
Deciding which structure suits your family comes down to how much control you want and who should access funds later.
Absolute (bare) options name beneficiaries who gain full entitlement on reaching 18 (16 in Scotland). Trustees must tell beneficiaries they are entitled. Once entitled, the fund can form part of that beneficiary’s estate and may pass under their will or by intestacy if they die.
Discretionary options give trustees choice over who benefits and when. No beneficiary can demand sums. A clear letter of wishes guides trustees and reduces family friction while keeping flexibility.
Practical trustee decisions often revolve around when to repay the outstanding amount, whether to make distributions, and how to record votes. Good minutes protect trustees and family members.
With joint settlors, the repayment right usually passes to the survivor. That can cause complications on separation or divorce, so many advisers prefer a single settlor to keep matters straightforward.
| Feature | Absolute | Discretionary | Practical tip |
|---|---|---|---|
| Beneficiary rights | Named beneficiary can demand at 18 (16 Scotland) | No automatic demand; trustees decide | Consider age thresholds and maturity |
| Estate impact | May become part of beneficiary’s estate on entitlement | Generally not in beneficiary estate while held | Review wills and potential IHT exposure |
| Trustee control | Limited once beneficiary is absolute | High: choose who benefits and when | Use a letter of wishes to guide decisions |
| Settlor arrangements | Single or joint possible; survivorship matters | Joint settlors add drafting complexity | Prefer single settlor where clarity needed |
Want tailored guidance? We can walk through which option suits your family and draft clear trustee instructions. See our practical guide on protecting property here: protect your property in trust.
Access, control and who can benefit from the trust fund
The practical rights inside the deed decide what the settlor may reclaim and what beneficiaries may expect.
The settlor’s rights: outstanding loan only
Golden rule: the settlor can call back only the outstanding loan, normally interest‑free and repayable on demand.
This means the settlor has access to the original capital sum, not the growth that sits above it. The outstanding loan remains part of the settlor estate while the growth is intended to sit outside.
Settlor exclusion clauses and avoiding benefit
Deeds usually include a clear settlor exclusion clause. That prevents the settlor from taking capital or income from the trust fund.
Its purpose is simple: remove any doubt that the settlor might benefit. That wording supports the expected estate treatment and avoids later challenges.
What beneficiaries can access and when
Beneficiaries do not have any right to the outstanding loan while the settlor lives. They benefit from growth and distributions only.
With absolute arrangements, named beneficiaries can demand capital on reaching majority (18; 16 in Scotland). With discretionary setups, beneficiaries cannot demand sums; trustees decide who benefits and when.
| Point | Absolute | Discretionary |
|---|---|---|
| Beneficiaries’ claim | Can demand on majority | No automatic claim; trustee discretion |
| Right to outstanding loan | None while settlor alive | None while settlor alive |
| Practical family tip | Explain timings and likely outcomes | Use letters of wishes to reduce surprise |
“If £200,000 is loaned and the bond grows to £260,000, the settlor can generally call back only £200,000; the £60,000 growth belongs to beneficiaries.”
Talk openly with adult children. That reduces misunderstanding where trustees have discretion and beneficiaries hold hopes rather than rights.
Inheritance tax treatment and reporting: entry, seven-year rules and ongoing charges
We start with a clear point: setting up a loan-only arrangement does not create a transfer of value. That is because the settlor retains a formal right to repayment, so there is no immediate IHT charge on entry.
When repayment rights are waived
If the settlor writes off part or all of the repayment right, the position changes. For absolute arrangements this creates a PET. For discretionary setups it becomes a CLT and may trigger an entry charge if other CLTs in the prior seven years exceed the nil rate band.
Nil rate band interactions and the 14-year timing point
The nil rate band matters if waived amounts aggregate with earlier CLTs. Most people never hit that threshold. But if a PET later fails, earlier CLTs can be pulled back into a 14-year window. That can alter the years counted and the final charge calculations.
Periodic and exit charges
Discretionary funds face ten-year periodic charges and possible exit charges. Practically, chargeable value is usually the bond value less the outstanding repayment right. That reduces the assessable sum when the bond has grown.
HMRC reporting and the excepted settlement test
Trustees must use Form IHT100D for ten‑year returns unless the arrangement qualifies as an excepted settlement. The critical nuance: the excepted test looks at the bond value, not the net after repayment rights.
Example: bond £261,000; outstanding repayment £200,000; net £61,000. Even though net is small, reporting is required because bond value exceeds £260,000 (80% of a £325,000 nil rate band).
We recommend trustees keep clear records and check thresholds early. For practical guidance on securing your family’s future see our guide.
Risks, drawbacks and common mistakes to avoid
If markets reverse and investment values shrink, the safety net can fray quickly.
What if the bond falls and the outstanding loan can’t be repaid?
There may not be enough in the fund to meet the outstanding loan. That creates practical shortfalls at the time of need.
Deeds often protect trustees unless loss stems from fraud or negligence. Liability depends on wording and conduct.
Why the outstanding loan stays in the settlor’s estate
The repayment right remains part of the settlor estate for iht purposes. That means some value may still face charge on death.
Administration and common legal pitfalls
Since 1 September 2022, register new trusts on the Trust Registration Service within 90 days. Update changes within 90 days too.
Wills must name who inherits the repayment right. If they do not, executors can be stuck at the worst time.
Never assign bond segments to settle the outstanding loan — that can trigger an income tax chargeable event gain.
Quick checklist — review regularly:
- Trustee details and provider statements.
- Letters of wishes and deed protections.
- Withdrawals versus 5% allowances and income tax risks.
- Whether part waiver still meets family goals.
Conclusion
Good trustee selection and careful record‑keeping make the difference in practice.
In short, a loan trust can reduce inheritance tax exposure by moving future growth outside your estate while you retain the repayable capital right. The trade‑off is clear: the repayment right stays in the settlor estate, yet the growth can benefit family members held by trustees.
Key choices shape outcomes: absolute or discretionary deeds, who acts as trustees, and whether parts of the loan are waived during your lifetime. Set the deed, advance funds, then place the bond in the fund in the correct order.
Families commonly take staged repayments within the 5% allowance and spend them, and sometimes waive small parts of the loan to crystallise long‑term benefit. Keep withdrawal records, meet TRS duties and check periodic returns.
If you want to explore whether this approach suits your goals, speak to a regulated adviser and read our inheritance tax guide.