30th October 2013
Canada Life: Adviser charging and the loan arranger
So far in this series of articles, we’ve looked at the situation with adviser charging for an investment bond and a discounted gift trust. Now let us consider the peculiarities of making an interest-free loan to trustees.
The initial consultation is with our client, Patrick McCoy, who is concerned about inheritance tax (IHT). However, he is not concerned enough about it to make an actual gift; because he is not yet retired he wants full access to his capital.
So his adviser recommends that he sets up a trust and, rather than make a gift, he lends a cash lump sum to his trustees. The trustees will be himself, his wife Clare and his eldest son, Barry.
It will be a discretionary trust and the possible beneficiaries are his children Barry, Tony and Tanya.
All well and good so far, but the adviser needs to be remunerated for all his hard work and his expertise. And more importantly, who is paying? Patrick or the trustees?
Obviously, Patrick received the initial advice about IHT and the type of arrangement to use. The adviser will also have mentioned to him, as one of the trustees, that an investment bond would be the ideal asset for the trust to hold.
So Patrick would pay an initial adviser charge for the advice he has been given personally. He could pay this separately or he could give the product provider the amount to be lent plus the adviser charge, with instructions that the adviser charge be deducted from the total.
He has £100,000 available in total and has agreed to pay an initial adviser charge of £3,000 personally. So Patrick is actually only making a loan of £97,000 net to the trustees.
The trustees effectively invest this amount in an investment bond. But which funds should they choose? Unless they have investment expertise themselves, they are duty-bound to take professional advice – and do so, from Patrick’s adviser.
Again, the issue of the adviser being paid for his advice is raised and this time, it is the trustees who should pay for it. Patrick, in theory, could have paid for it on behalf of the trustees, and if he did so that would be treated as a gift for IHT purposes.
The trustees are entitled to withdraw money from the cash they have borrowed or their investment bond in order to pay the adviser charges. They agree with the adviser that, as he gave advice about the suitability of an investment bond and because their investment will be monitored by the adviser, they will pay him an ongoing adviser charge every month.
If this is derived from the bond, it will be a withdrawal (or partial surrender) so will be treated as part of the 5% tax-deferred allowance. This is a complication nowadays, because Patrick was considering taking loan repayments of 5% each year, which the trustees would fund by making withdrawals.
Adding an ongoing adviser charging on top would create an ‘excess’ chargeable gain each year and possibly generate a tax bill for Patrick (as the settlor), depending on his circumstances and whether the investment bond held by the trustees was onshore or offshore.
The answer could be to reduce the loan repayments by the amount of the ongoing adviser charges, but that again causes complications:
- If the ongoing adviser charge was fund-related, the total of loan repayments plus the adviser charge would rise above the 5% limit when fund growth occurred
- The loan repayment (in this example) would not take place over a nice simple 20 years but an extended fractional term
It would make life simple for all if Patrick paid the ongoing adviser charges separately on behalf of the trustees. This would be a further gift, as discussed before, and assumes the adviser can overcome the natural reticence of clients to set up standing orders or direct debits for fees.
In addition, having fund-related charging could be an administrative nightmare.
As regards the first point, fortunately some product providers are able to offer the facility to incorporate a maximum amount on the withdrawals used to pay ongoing adviser charges. So Patrick could take a withdrawal of 4.25%, the trustees agree an ongoing adviser charge of 0.5% of the fund value, with a 0.75% cap to prevent the total withdrawals exceeding the 5% allowance.
It should be remembered that the actual amount invested was £97,000 so Patrick’s withdrawal is £4,122.50 a year and the ongoing adviser charge is capped at £727.50 a year; the total being £4,850 which is 5% of £97,000.
If nothing else, adviser charging has made the mathematics more complicated.
Because as regards the second point, Patrick’s loan repayments at his chosen rate can continue for 23 years – with a bit left over!
Making an interest-free loan is still a credible way of mitigating inheritance tax, you just have to tread carefully nowadays where adviser charging is concerned.
Jeremy Pearson
Technical Support Manager
Canada Life Limited
01707 422999
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