Client Guide: Providing for your children and grand children

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Why and how to provide for your children or grandchildren will very much depend on your age and their age.  

The younger you and they are, the more your priority may be securing assets for their future.  As you and they get older, your focus may be more on tax planning and giving them control of assets.

What you might want to consider

If you are able to, you could use the following means to transfer assets to your children as this will reduce the possible impact of Inheritance Tax (IHT).

You could use the annual exemption to give away £3,000 a year.  This means a married couple could together give £6,000 divided between their children and grandchildren each year without any IHT implications.

The normal expenditure out of income exemption is also available if you have sufficient income.  Regular gifts to children or grandchildren out of your excess income that is not required to meet your living expenses and would otherwise be saved is a useful way to give money without IHT implications.  Care does need to be taken in using this exemption as the claim for this on your death can be difficult and it is important that you maintain good records.

There is also an exemption from IHT for money that is set aside in a particular way for the maintenance or education of your children whilst they are under 18 or in full time education.

A word of caution

There are often good reasons why a child should not come into possession of significant assets on his or her eighteenth birthday and a trust can be used to leave the control of assets in the hands of responsible people till a later point, such as a twenty-first or twenty-fifth birthday.  It is therefore possible to use these IHT exemptions by giving the cash sums to a trust instead of directly to children or grandchildren.

The two most common forms of trust used (since legislative changes in 2006) are bare trusts and discretionary trusts.  It remains possible to create contingent trusts where children are not entitled to receive the assets in the trust until they reach a special age, possibly 21, 25 or 30.  These are now treated in the same way as fully discretionary trusts.

Bare trusts

This is a simple arrangement where assets belong to a person under 18 but are held by a trustee or trustees. An example of this is a savings account in the name of a parent but designated with the child's initials to indicate that the money really belongs to the child. The trustees have the authority to see that the assets are properly invested and they may use them for the benefit of the beneficiary. If on reaching 18 the beneficiary requests the assets in the trust, the trustees are required to hand everything to the beneficiary. The trust is taxed as if the assets were the child's. (There are special rules where the child's parents created the arrangement.)

Discretionary trusts

A discretionary trust is a flexible way of providing for a group of people.  A discretionary trust differs from other trusts in that no single beneficiary is entitled as of right to any particular part of the trust property.  The trustees choose which of the beneficiaries should benefit from the trust and in what manner.  The trustees look at all the circumstances both financial and personal of the beneficiaries and decide in what manner the beneficiaries would best benefit from the trust.  For example, it may be better to pay rent and living expenses direct rather than giving the money to the beneficiary.  Purchases such as a car or household goods may also be made direct.

The discretionary trust is therefore very useful where children need strict control with their finances and it is thought inadvisable for them to receive large amounts outright.  Also if a beneficiary receives social security benefits, the payments from the trust can be made in such a way that those benefits are not lost.

The terms of the trust can be very wide and include whatever provisions are thought to be needed to benefit the beneficiaries in the best possible way.  The trust can also be used so that certain beneficiaries are benefited in different ways from others.  For example, one could be given large capital sums whilst another receives a regular income.

Where a discretionary trust is being set up for the benefit of a child we advise that an informal letter is addressed to the trustees giving guidance as to why the trust was set up, how the people setting up the trust would like the trustees to use their powers and the circumstances in which they would envisage the trustees helping the beneficiary.  For example, it could be suggested that payments should not be made to a beneficiary regarded as a spendthrift until he shows that he can be more responsible.  Such letters cannot have legal force but are usually followed.

When someone sets up a discretionary trust it is immediately chargeable to IHT.  However this is only if the amount put into the trust exceeds the nil-rate band.  This is currently £325,000 (2014/2015).  Anything over that will be taxed at 20%.  In addition, charges arise to IHT (at a maximum rate of 6%) at certain times, for example every tenth anniversary.  Income tax is charged at 45% on income generated by the trust's assets each year which exceeds £1,000 (2014/2015) and Capital Gains Tax is charged at 28% on capital gains on the trust's assets over £5,450 (2014/2015).  If the person who places funds into the trust or a child of theirs who is under 18 is a beneficiary and they can benefit before reaching 18, the taxation of the trust will be different to that set out here.

A discretionary trust can run for a maximum of 125 years, although the trustees can (and almost always will) agree to bring it to an end before then.

Contingent trusts

This type of trust is one when the beneficiary becomes entitled to all or a share of the assets held by the trustees when they reach a certain age.  They may become entitled to income at 18 and then have to wait until they are older to receive capital.

As mentioned above, these types of trusts did have preferential IHT treatment in the past but they are now subject to IHT in the same way as a fully discretionary trust which is why some people now prefer to have the flexibility of a discretionary trust rather than a contingent trust.

Whichever form of trust is chosen, the trustees will have certain tasks to undertake such as completing an annual tax return, reviewing investments and preparing trust accounts. If they seek professional help, there will be some expense incurred each year.

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