Christmas is a time when many older investors think about giving money to their grandchildren to assist with their education and to set them up for adult life. A bare trust can often help.
Why do I need a bare trust?
Children cannot own shares except through a Junior ISA (JISA) or a pension, which has to be opened by the parent or guardian.
Junior ISAs are useful but you can only invest £4,128 (2017/18) in a tax year and the money is locked in till the child is 18, at which point they can take control of it and splash the cash.
You can invest £3,600 (£2,880 net of basic rate tax relief) each tax year into a pension for a child, but then the money is locked up even longer.
You can give the money to the parents to invest and use at their discretion, but the assets are in their name and any income and realised capital gains are assessed to the parents for tax purposes. There is also the problem of what happens if your son or daughter separate. Many parents are not confident about the security of their child’s marriage (even though they’re usually sensitive enough not to say so!). They fear that money they worked hard to save and pass to a grandchild could find itself wrapped in a divorce settlement, seeping out of the family’s hands. This is where the bare trust comes in useful.
What is a bare trust?
Under a bare trust the assets are registered through an account set up by the parents in their name and designated with the child’s initials. This establishes the bare trust with the parent holding the assets as trustee for the child as beneficiary. The child can then take advantage of their own income tax and capital gains tax allowances. A bare trust also protects the money in the event of divorce.
You can set up a bare trust very easily with the help of a financial adviser – we have done these for many of our clients. Funds must be used for the child’s benefit. This might include educational costs together with extras like uniform, music lessons and expensive school trips. When the child reaches 18 he or she has the right to take control of the money, hopefully using it towards university costs or the deposit for a house.
Inheritance tax benefits
There are no limits as to how much you can put in a bare trust. If you’re looking to reduce the inheritance tax (IHT) liabilities on your estate this can be useful.
The rules around IHT are complex. Tax treatment depends on individual circumstances and is subject to change in future it is worth seeing an adviser and reviewing your strategy regularly if this affects you. In simple terms, you (and your spouse) can each give £3,000 a year that is IHT exempt. If you’ve not given anything in the previous tax year you can carry forward unused allowances for one year, so could give up to £12,000 between you.
Most other gifts above this would be considered “Potentially Exempt Transfers”. These are free from IHT if you survive seven years. If you survive between three and seven years, the IHT liability may be judged on a sliding scale. But there is a useful IHT exemption, called the “normal expenditure rule”, which allows you to make gifts out of your after-tax income as part of your normal spending plans. The key challenge is to prove that sacrificing income like this does not lead to a demonstrable reduction in your standard of living – in other words, that you can easily afford it.
For those on very high incomes in retirement – and this is particularly true of those on high final salary pension schemes who cannot control the level of income they receive in retirement – giving sometimes significant sums of money regularly to grandchildren is not a hardship. These people are often being taxed at 40% or more on their pension income and could then find these assets taxed again at 40% on their death through IHT so this is a good way of limiting the pain to just income tax.
Regular monthly giving is a good way of demonstrating to the tax man the affordability of the gift (and there are no limits to how much you can give if it passes the affordability test). It can help reduce the value of your estate immediately, helping cut the IHT bill later. If you are investing, it is also a good way of enjoying the benefits of “pound cost averaging”. This is where money is drip fed into the markets regularly so that you avoid the possibility of investing a big lump sum right at the top of the market.
Of course if you are giving money for a grandchild you need to think carefully about how it is invested. This will depend on whether you are investing for the long term or whether the money is needed more immediately. There are a number of options available and we can discuss them with you to find the best solution for your family’s situation.
This is an updated version of an earlier piece – posted 18 December 2017
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