The schemes, known as loan trusts or gift-and-loan trusts, continue to be sold in large numbers, even though they are under threat from new rules on tax avoidance that were first announced in December.
Susan Johnson of Moore Stephens, an accountant, said: “Customers who have been sold the schemes over recent months have a genuine grievance if they were not warned that they could be caught out by the new rules.”
Most insurers are selling hundreds of the schemes every month.
Gift-and-loan trusts first came on to the market in 1986. If the insurers cannot convince the Inland Revenue to back down, hundreds of thousands of people could be forced to dismantle the trusts or pay a hefty tax charge.
Avoidance schemes have become increasingly popular as more people have been dragged into the IHT net. Your heirs are currently liable for IHT at 40% on estates of £263,000 or more.
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An estate includes your family home, and soaring house prices have pushed thousands more people into the IHT bracket. House prices have surged by 130% since Labour came to power in 1997. Over the same period the IHT threshold has gone up by just 22%.
As more people try to protect their wealth from the 40% tax, insurance companies, accountants and solicitors have devised a number of avoidance schemes.
The government has responded with legislation to outlaw most schemes from April 2005. This crackdown will affect people who give away assets with the intention of cutting an IHT bill but continue to benefit from the gift. In future, the government will slap an annual charge on the “benefit”.
For example, you will not escape tax if you give your home to your children and continue to live in the property rent-free. The tax charge will apply to arrangements in existence when the rules are introduced in April next year, even if they were set up as far back as 1986. You will not, however, have to pay backdated tax.
The only way to avoid the tax charge is to dismantle the scheme or elect to bring the assets back into your estate for IHT purposes.
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If you set up a gift-and-loan trust you make an initial payment — a gift — into the trust, usually of £3,000. You can give away £3,000 each tax year and the money does not count towards your estate for IHT purposes. The £3,000 gift is therefore immediately tax-free.
You then make a bigger payment to the trust, which is treated as an interest-free loan. The trustees invest this money, usually in a single-premium insurance bond.
Returns from insurance bonds are paid net of basic-rate tax. Higher-rate taxpayers can withdraw 5% of the capital every year, with no immediate tax to pay. The tax owed — the difference between basic and higher rates — is not paid until the bond is encashed.
The advantage of the scheme for your heirs is that growth in the investment is IHT-free. You can withdraw the original capital, but no more. Loan trusts work the same way, but without the initial gift.
Insurers last week defended their decision to continue selling the schemes to customers. The Association of British Insurers said: “The Revenue originally told us that these trusts would escape the crackdown, but now it has told us they will be included.”
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Some firms still believe the schemes may escape the legislation on a technicality.
Paul Kennedy at Prudential said: “With these schemes you gift the growth in the trust, which is something you can never access. You are not benefiting from the assets you are giving away, so the trusts should fall outside the legislation.”
Insurers have now agreed to put warnings on the schemes to alert customers that they may soon fall foul of the law. However, most companies have not withdrawn them.
The government is still consulting on the details of the legislation and is expected to confirm the regulations in the pre-budget report in the autumn.
People will have until January 31, 2007 to dismantle tax-avoidance schemes but they will have to decide whether to cash in their bonds. They will also be able to register to bring their assets back into their estates for IHT purposes.